Docstoc

KPMG final

Document Sample
KPMG final Powered By Docstoc
					      European Commission

  Study into the methodologies for
prudential supervision of reinsurance
     with a view to the possible
 establishment of an EU framework

            31 January 2002
 Contract no: ETD/2000/BS-3001/C/44




                    KPMG
         This report contains 157 pages
         Appendices contain 16 pages
                  mk/nb/552
Contents

1     Introduction                                                      4
1.1   Summary                                                            4
1.2   General Approach                                                   5

2     Similarities and differences between insurance, reinsurance
      and other risk transfer methods                                   6
2.1   Scope                                                              6
2.2   Approach                                                           6
2.3   Definitions                                                        6
2.4   Similarities between insurance and reinsurance                     7
2.5   Differences between insurance and reinsurance                      9
2.6   Other methods of risk transfer                                    13
2.7   Preliminary conclusions                                           15

3     Reinsurance and risk                                              16
3.1   Scope                                                             16
3.2   Approach                                                          16
3.3   Risks                                                             16
3.4   Systemic risks                                                    21
3.5   Assessing the importance of different risks                       22
3.6   Conclusion                                                        27

4     Description of the global reinsurance market                      28
4.1   Scope                                                             28
4.2   Approach                                                          28
4.3   The global reinsurance market                                     28
4.4   The major reinsurance products                                    30
4.5   The role of offshore locations                                    35
4.6   Captives                                                          36
4.7   The future evolution of the market and developments in products   37
4.8   Competitive position of EU reinsurers from a global perspective   38

5     Description of the different types of supervision
      approaches currently used in the EU as well as other major
      Non-EU countries                                                  39
5.1   Scope                                                             39
5.2   Approach                                                          39
5.3   Introduction: reasons for supervision                             39
5.4   Supervising authority                                             40
5.5   Forms of supervision                                              41
5.6   Supervision of reinsurance in the EU                              42
5.7   Supervision of reinsurance in major non-EU countries              61
6      The rationale with regard to supervisory parameters                           71
6.1    Scope                                                                         71
6.2    Approach                                                                      71
6.3    Extent of supervision                                                         71
6.4    Overview of supervisory parameters                                            74
6.5    Parameters relating to direct supervision                                     76
6.6    Parameters relating to indirect supervision                                   97

7      The arguments for and against reinsurance supervision and
       a broad cost-benefit analysis                             106
7.1    Scope                                                                        106
7.2    Approach                                                                     106
7.3    Arguments for reinsurance supervision                                        106
7.4    Arguments against reinsurance supervision                                    109
7.5    Impacts on the different approaches to supervision                           112
7.6    Cost-benefit analysis                                                        112

8      Summary of reinsurance market practice for assessing risk
       and establishing technical provisions                     117
8.1    Scope                                                                        117
8.2    Approach                                                                     117
8.3    Market practice for assessing risk                                           117
8.4    Establishing adequate technical provisions                                   118
8.5    Management of underwriting risks                                             123
8.6    Monitoring credit risk                                                       132
8.7    Management of investment risks                                               133
8.8    Management of foreign currency risks                                         134
8.9    The role of securitisation                                                   136
8.10   Financial condition reporting                                                140
8.11   Summary                                                                      141



Appendix I – Description of certain reinsurance arrangements                        142
Appendix II – Overview of other important captive domiciles                         146
Appendix III – Lloyd's: summary of the regulatory approach                          147
Appendix IV – Detailed description of actuarial reserving methods used              151
Appendix V – Main sources                                                           155

This report was commissioned by Internal Market Directorate General of the European
Commission. It does not however reflect the Commission’s official views. The
consultant, KPMG Deutsche Treuhand Gesellschaft, Cologne, is responsible for the facts
and the views set out in the document. Reproduction is authorised, except for commercial
purposes, provided the source is acknowledged.
Foreword by the Commission Services
The reinsurance sector has seen important changes during the last few years. The concentration
to a few large players has continued through mergers and acquisition, new financial products
have been developed and new information technology tools have emerged. The tragic events of
11 September 2001 will also have strong repercussions on the reinsurance industry, both as
regards practices and available capacity. These developments make it even more important that
a solid system of reinsurance supervision is in place to ensure that companies fulfil their
obligations. The security of the reinsurance arrangements of a primary insurer is clearly of vital
importance for the protection of its policyholders.

In a changing market it is important that supervisory practices keep pace with developments. In
the EU there is currently no harmonised framework for reinsurance supervision, and this has led
to significant differences in approach between Member States. Such differences may duplicate
administrative work and may also create barriers to a properly functioning internal market for
reinsurance services.
In January 2000, the Commission Services and Member States therefore decided to initiate a
project on reinsurance supervision to investigate the possible establishment of a harmonised EU
system. As a thorough investigation of all the different aspects involved is very complex and
extensive, the Commission Services and Member States agreed to commission a study to
provide the working groups with background research and discussion material.

The Commission Services are pleased to present this study, which was prepared by a team from
the KPMG under the supervision of Keith Nicholson and Joachim Kölschbach. We believe that
the study presents a clear and pedagogical overview of the reinsurance market and reinsurance
supervision. We also hope it will stimulate further debate in Member States, at the EU level and
internationally. Please note that although the study was commissioned by the Directorate-
General Internal Market, it does not express the Commission’s official view. The consultants
remain responsible for the facts and the views set out in the report.

The Commission Services invite interested parties to send their comments on this study to:
MARKT-C2@cec.eu.int.

Please also note that the Insurance Unit of the Commission has a website, where other
documents of interest can be found:
http://europa.eu.int/comm/internal_market/en/finances/insur/index.htm

Brussels, January 2002


Jean-Claude Thébault
Director




                                                                                          3
1     Introduction

      This report outlines our findings on the “Study into the methodologies for prudential
      supervision of reinsurance with a view to the possible establishment of an EU framework”.

1.1   Summary
      Chapter 2 of this report gives an overview of similarities and differences between insurance,
      reinsurance and other risk transfer methods. The section focuses on those similarities and
      differences which are relevant to the prudential supervision of insurance and reinsurance. The
      major methods of risk transfer in reinsurance business are described. The concept of alternative
      risk transfer solutions is also considered, by reference to different types of contracts.

      Chapter 3 identifies the main risks that reinsurance companies are exposed to. The section
      differentiates between different kinds of products, different lines of business and other activities
      performed by reinsurance companies. This section summarises the most relevant risks in a risk
      matrix and gives preliminary views of mitigating strategies. The section includes a discussion of
      specific risks relating to different reinsurance activities.

      Chapter 4 provides an overview of the global reinsurance market. It discusses the main market
      players, different jurisdictions, the role of offshore locations, the major reinsurance products and
      the likely evolution of the market and product developments.

      Chapter 5 provides a description of the different approaches to supervision adopted in the EU
      and in major non-EU countries. It includes a comparison of the principal characteristics and
      differences of major or leading jurisdictions, with the aim of clarifying the rationale underlying
      the adopted supervisory approach. This section is based on discussions with industry specialists
      within the relevant jurisdictions (both within and outside KPMG).

      Chapter 6 analyses the rationale underlying various supervisory parameters and the relative
      importance and feasibility of supervising the parameters in question. Based on key risks, the
      analysis prioritises the products / activities of reinsurance companies by their relative need for
      supervision.

      Chapter 7 analyses the arguments for and against reinsurance supervision. Based on the goals
      of supervision, the risk analysis, and current practices, this section includes a broad cost-benefit
      analysis of supervisory approaches.

      Chapter 8 provides a summary of techniques currently employed for monitoring key risks. It
      analyses the impact of securitisation and how reinsurers measure or take into account portfolio
      diversification in assessing their own capital requirements.

      The study also examines approaches adopted by reinsurance companies and other interested
      parties (such as rating agencies) to assess and monitor reinsurance risks. The study considers the
      ways in which supervisory approaches may benefit from existing market practices.

      Our analysis is focused on individual reinsurance companies as well as on reinsurance groups.




                                                                                                  4
1.2   General Approach
      The work was performed using our knowledge of the reinsurance industry and based on detailed
      information requested from various KPMG offices. We have also researched information
      sources to obtain articles and data.

      We have had regard, in particular, to the Issues Paper on Reinsurance1 produced by the
      International Association of Insurance Supervisors (IAIS) Working Group on Reinsurance
      (dated February 2000), and references are made as appropriate throughout the report.

      We have conducted a programme of visits to a wide selection of reinsurance undertakings in
      order to obtain detailed views and opinions on a variety of issues within the scope of the study.




      1
          Reinsurance and reinsurers: relevant issues for establishing general supervisory principles, standards
          and practices, February 2000




                                                                                                         5
2       Similarities and differences between insurance, reinsurance
        and other risk transfer methods

2.1     Scope
        In accordance with the Terms of Reference, this chapter provides “an overview of the
        similarities and differences between insurance, reinsurance and other risk transfer methods
        especially from the supervisory point of view”.

2.2     Approach
        In reporting on the above objective, we undertook the following approach:

        § Use of existing specialist knowledge to describe various major methods of risk transfer using
          examples of policies and contracts.

2.3     Definitions
2.3.1   Insurance
        As defined by the IAIS Working Group on Reinsurance, “insurance can be defined as an
        economic activity for contractually reducing risk for the policyholder in return for a premium”.

        Whilst the transfer of risk is the underlying feature of all insurance products, there are other
        financial elements which may be present in certain types of contract, such as guarantees,
        investment components and derivatives.

        The Insurance Steering Committee of the International Accounting Standards Committee
        suggests the following definition of an insurance contract:

        “An insurance contract is a contract under which one party (the insurer) accepts an insurance
        risk by agreeing with another party (the policyholder) to compensate the policyholder or other
        specified beneficiary if a specified uncertain future event adversely affects the policyholder or
        other beneficiary (other than an event that is only a change in one or more of a specified interest
        rate, security price, commodity price, foreign exchange rate, index of process or rates, a credit
        rating or credit index or similar variable).”2




        2
            Draft Statement of Principles (DSOP); Insurance Steering Committee, IASC, June 2001




                                                                                                   6
2.3.2   Reinsurance
        The IAIS Working Group defines reinsurance as “the form of insurance where the primary
        insurer reduces the risk by sharing individual risks or portfolios of risks with a reinsurer against
        a premium”.

        Reinsurance is “insurance for insurers”. The basis of most reinsurance arrangements is the
        spreading of risk and, in essence, reinsurance allows the insurer to take on an insurance risk and
        subsequently pass on all or part of that risk to a reinsurer. As a result, the original company is
        left with only a part of the original risk (although in law the insurer remains liable to the
        policyholder for the full amount of the claim, and if the reinsurer defaults or becomes insolvent
        the insurer is obliged to meet the full amount of any claims).

        Reinsurance contracts can take a number of different forms. Appendix 1 provides details of the
        common forms of reinsurance contract.

        Reinsurance business is similar to insurance business in a number of ways, and supervisors in
        certain jurisdictions, both within and outside the EU, have developed regulatory regimes for
        insurance business which encompass reinsurance. In some cases, whilst the legislative
        framework of regulation makes little or no distinction between insurance and reinsurance,
        supervisors may take a somewhat different approach in practice. In other cases, reinsurance is
        treated differently within the regulatory legislation. Despite the similarities, there are
        fundamental differences between insurance and reinsurance, which can have a significant
        impact upon supervisory objectives.

        In order to assess the rationale for different supervisory approaches, it is necessary to examine
        those similarities and differences between reinsurance and insurance which are of relevance to
        prudential supervisors.

2.4     Similarities between insurance and reinsurance
        The areas of similarity between insurance and reinsurance business help to explain the rationale
        for a similar regulatory approach in certain jurisdictions. The main similarities are discussed
        below.

2.4.1   Transfer of insurance risk
        Both insurance and reinsurance contracts allow for the indemnification of an insured (or
        reinsured) in the event of loss in consideration of a premium. The key features of the business
        cycle involved in both cases are very similar, through underwriting, investment, claims, control
        over expenses, and the reinsurance (and for reinsurers, retrocession) programme. Both the
        insurance and reinsurance cycles generally have similar types of systems and controls.

        The types of risk which both types of business are exposed to are also broadly similar, for
        example, occurrence of claims events, timing and quantum of claims, severity, development,
        and specifically for life business, mortality, morbidity and longevity. Reinsurers are subject to
        the same sources of risk, for example, the random occurrence of major claims events and
        fluctuations in the number and size of claims.




                                                                                                    7
        Because the transfer of risk is a common feature, it could be assumed that the reasons for
        purchasing insurance and reinsurance protection are also similar. Insurance provides protection
        for policyholders; reinsurance also provides protection, to primary insurers. However, there are
        a number of reasons why insurers buy reinsurance:

        § it allows the insurer to increase capacity to underwrite business;

        § it allows insurers to limit their exposure to risk and reduces volatility and uncertainty in the
          insurer’s results;

        § reinsurers can provide experience and expertise in new lines of business or new geographical
          markets;

        § reinsurers can provide a financing role.

        Primary insurers are dependent, to a varying extent, upon the reinsurance industry. A key
        feature of reinsurance is the need to diversify risk. The spreading of insurance risk around the
        market through the use of reinsurance creates a highly inter-related marketplace in which a
        major loss event can impact upon many participants in the market. At a fundamental level,
        failure in the reinsurance industry will have an impact upon insurers and in turn on their
        policyholders.

        The special case of financial reinsurance is described in section 2.6.1.2.

2.4.2   Credit risk (exposure to bad debts)
        Among the risks faced by both insurers and reinsurers is the possibility of exposure to bad
        debts. For insurers, whilst bad debts can arise from a variety of sources (including
        intermediaries), exposure usually arises principally from the outward reinsurance programme,
        and the same is true for reinsurers in respect of their retrocessionaires.

        From a supervisory point of view, the security of reinsurers (and retrocessionaires) is a major
        issue when assessing the financial position of an insurance or reinsurance undertaking.

2.4.3   Investment risk
        A key feature of both insurance and reinsurance business is the investment of assets to support
        insurance and reinsurance liabilities. Investment return is usually a key component of total
        profits generated by such operations. Both insurers and reinsurers need to manage their
        investment risks, balancing the need to maintain a prudent spread of investments, whose risk is
        appropriate to the risk profile of the insurance and reinsurance liabilities, with the need for
        adequate investment returns.

        Whilst some in the industry argue that investment activities are managed separately from the
        underwriting activities, there is a trend towards the view that investment activities are an
        integral part of the management of insurance or reinsurance business. In either case, reliance on
        investment returns is a major feature of insurance and reinsurance, and exposure to the
        variability of stock market performance and interest rate movements is common. In the case of
        non-life insurers and reinsurers, investment in equities is generally less common, although
        shareholders’ assets can be significantly affected by changes in values of equities and, to a
        lesser extent, bonds.




                                                                                                  8
        From a supervisory point of view, it is important to be able to distinguish between the
        underwriting results and the results of investment activities. It is difficult to assess real trends in
        underwriting performance if the results are obscured by investment returns. Also, it is important
        to be able to assess the additional strains on capital arising from investment losses. This applies
        to insurance and reinsurance.

2.4.4   Distribution channels: Use of intermediaries and direct writers
        Both insurers and reinsurers have traditionally obtained business through the use of
        intermediaries. In recent years, various insurance companies have set up direct selling
        operations to market and sell their products avoiding the use of intermediaries.

        Direct selling can reduce costs and puts insurers in direct contact with their customers at the
        point of sale. It also creates potential for greater understanding of their policyholders and
        increased opportunities for marketing their products. However, the traditional involvement of
        brokers continues to be important.

        A similar trend has occurred in the reinsurance industry, where a number of companies have
        started to deal directly with their customers in the primary insurance market. The reasons cited
        include the potential for developing direct long term relationships as well as savings in
        commissions paid to brokers. Nevertheless, brokers in the reinsurance markets continue to have
        an important role.

2.5     Differences between insurance and reinsurance
2.5.1   Types of contract and complexity
        Whilst the effects of insurance and reinsurance contracts are fundamentally similar (that is, the
        transfer of risk), the types of contract involved are usually different.

        Broadly, insurance usually involves the use of standardised policies. This is certainly the case in
        personal lines business (such as private motor and household). For commercial lines (including
        industrial risks), it is common to find more customised policies, especially for larger risks.
        Reinsurance contracts, however, usually tend to be drawn up on an individual basis to meet the
        particular requirements of the cedant. Reinsurance contracts may include limitations and
        exceptions that are not common or permitted for direct insurance contracts. These contractual
        provisions usually limit the reinsurer’s exposure to risk.

        A contract of insurance usually involves coverage of a single risk, or a package of risks,
        between the policyholder and the risk carrier. Reinsurance is often underwritten on a treaty
        basis. Whilst facultative reinsurance involves an individual risk, treaty business covers a
        portfolio of insurance contracts over a specified period. Appendix 1 provides examples of the
        common types of arrangement. These differences should be of importance to supervisors
        because the population of risks in a reinsurer’s portfolio is usually more complex. Reinsurers
        not only underwrite contracts with primary insurers, but also other reinsurers, as
        retrocessionaires.

        These factors mean that a deep understanding of the business is required in order to be in a
        position to make sensible assessments of a reinsurer’s true financial position.




                                                                                                       9
2.5.2   Volatility
        Reinsurance business tends to be more volatile than primary insurance. There are a number of
        reasons for this:

        §   for insurers involved in conventional personal and commercial lines business, the book of
            business usually consists of a greater number of policies, each of which has relatively small
            exposure. Reinsurers tend to write business on a treaty basis, and are exposed to the
            accumulation of losses and greater likelihood of significant losses;

        §   primary insurers generally tend to have lower retentions than reinsurers; the outward
            reinsurance programme offloads risk and reduces uncertainty at the level of the primary
            insurer;

        §   reinsurers are involved, particularly in relation to non-proportional (excess of loss) business,
            in higher levels of cover, where the incidence of claims is less frequent but larger in amount.
            Exposure to catastrophes is a particular feature of the reinsurance industry. A single
            catastrophic event will usually lead to claims on numerous reinsurers, as risks are typically
            spread around the market.

        The volatility of business is closely linked to the underlying complexity in reinsurance business,
        and this has implications when assessing financial strength. However, the effects depend upon
        the individual situation; volatility, whilst still present, will be lesser for a reinsurer which allows
        for better diversification and pooling of individual risks within a larger or well structured
        portfolio. Also, volatility will be mitigated to some extent by retrocession arrangements.

        It has not been proven that the residual risk of pure reinsurance companies is higher than the
        risk of direct insurance companies.

2.5.3   Globalised portfolios
        Reinsurance is normally a global business. Companies tend to reinsure risks from a number of
        insurers located in many jurisdictions. Therefore, reinsurers usually have a broad range of
        geographical exposures. This is a key feature of reinsurance in achieving diversification of risks.
        The insurance industry, on the other hand, tends to be more local in nature. Whilst there are
        some global insurance companies, they usually operate with local subsidiaries in different
        territories. The reinsurance industry is far more concentrated in the hands of a small number of
        major global participants, combining international risks within one portfolio. Due to the nature
        of reinsurance business, diversification in the portfolio is an essential feature in the risk
        management process. Diversification tends to be geographical as well as by risk-type.

        From a supervisory point of view this is a key difference. Supervisors tend to be aligned on the
        basis of nation states, but reinsurers often manage their business on a wider geographical basis.
        The globalised nature of a reinsurer’s business means that supervision on a local basis is
        inherently difficult. For example, global knowledge of major claims events in markets in which
        the reinsurer has exposure can be of critical importance in assessing the impact on the financial
        position of a company.




                                                                                                     10
2.5.4   Delay in claims reporting, other information, and cash flows
        Compared to insurance business, reinsurance is often characterised by time delays in the receipt
        of information about contracts entered into. Reinsurance is at least one additional stage removed
        from the underlying insured event. There are various reasons for delays:

        §   insurers need to process policies and claims first before passing on information, which in
            turn may be passed via brokers;

        §   reinsurance contracts often involve a number of different reinsurers taking lines; a reinsurer
            may lead or follow on a contract. Even with central processing and settlement systems, there
            can be time lags in the receipt of information;

        §   insurance companies may also suffer from some time lags in receipt of information, but the
            position for reinsurers is usually worse as they rely on the submission of information from
            cedants.

        Reinsurers receive their premiums later than ceding companies, (due to procedures for
        settlement of accounts), but may on the other hand be required to make immediate cash
        payments when large losses occur. This can result in fewer opportunities to compensate
        underwriting losses by investment income (“cash flow underwriting”) than for direct insurers.

        A related issue is that reinsurers will not necessarily know about the impact of certain claims
        events until the claims have worked through the retentions and lower levels of cover. A
        reinsurer therefore needs to have effective processes to monitor exposures and the likely
        impacts of claims events in the markets. For example, the incidence of subsidence claims on
        household policies may take some time to accumulate to the point where insurers start to make
        recoveries on their excess of loss protections.

        From the supervisory perspective, these differences are important because they can make it
        more difficult to detect potential problems which may impact upon a reinsurer’s financial
        position.

2.5.5   Reliance on others’ knowledge
        As a result of various intermediaries involved (insurers or lead reinsurers), the reinsurer may
        have a diluted understanding of the risk being transferred. Reinsurers therefore tend to be reliant
        on second-hand knowledge to obtain an understanding of the underlying risks. They also need
        to have sound management systems and controls in order to ensure that sufficient understanding
        of the book of business being reinsured is obtained. This applies both to underwriting and
        claims management.

        In proportional treaties, for example, the reinsurer follows the fortunes of the reinsured and, in
        order to make accurate assessments about the risk involved in writing a treaty, needs to know
        not only the type of business being written, but also the risks posed by the insurer’s own internal
        arrangements, the quality and track record of its management, its systems and controls over
        acceptance of risks and claims, and its approach to risk management and pricing.

        Various examples can be cited to demonstrate this lack of knowledge or understanding of the
        underlying risks, which has ultimately led to financial difficulties for reinsurers. For example
        European reinsurers, writing employers and environmental liability policies in the United States
        faced a subsequent surge in claims, particularly relating to asbestosis.




                                                                                                  11
        The larger reinsurers tend to be in a better position to cope with such problems, having
        resources to acquire deeper technical expertise in the markets and lines of business in which
        they are involved.

        The relative remoteness of reinsurers from the underlying risks, and the consequent reliance on
        information supplied by insurers and intermediaries, combined with the ways in which
        reinsurance contracts operate, results in the possibility for sudden impacts upon claims
        provisions as information becomes available to the reinsurer. This tendency is important in
        understanding the financial position of a reinsurer and is therefore relevant to prudential
        supervisors.

2.5.6   Profit commissions and premium adjustments
        Due to the generally higher uncertainty and less detailed knowledge of reinsurers of the
        underlying risks, the pricing mechanisms in reinsurance contracts are often adjustable.
        Insurance contracts can also have adjustable terms, but this tends to occur in the case of
        commercial lines, especially for larger risks, rather than personal lines business. This feature of
        the contract gives the reinsurer more scope to collect further premiums should the business turn
        out to be less profitable than expected. Profit commissions, reinstatement premiums and
        premium adjustments are incorporated in contracts as a way of sharing the risks and rewards
        with the cedant as well as minimising the costs of reinsurance.

        The risk exposure in the case of reinsurance contracts with adjustable pricing arrangements
        tends to be lower than that in the case of those with fixed price arrangements. Accordingly, an
        understanding of the types of contract written is important in making an assessment of a
        reinsurer’s overall risk profile.

2.5.7   Professional counterparties
        Reinsurance business takes place in the professional marketplace. Whether directly with
        primary insurers, or through intermediaries, reinsurers deal in virtually all cases with
        professional counterparties. Whilst this would be relevant in the context of conduct of business
        issues, the question arises as to the relevance from the viewpoint of prudential supervision. The
        point is relevant because it can be argued that the inter-professional market place is to some
        extent self-regulating.

2.5.8   Use of rating agencies
        As part of an insurer’s assessment of the credit-worthiness of a reinsurer, there is normally a
        significant reliance on the ratings provided by rating agencies. The largest reinsurance
        companies all have ratings from the main agencies. Credit ratings are also important in the
        context of primary insurance companies, but tend not to be used extensively where private
        consumers are concerned, due to the protection afforded by guarantee schemes in many
        territories.

        From a supervisory perspective, this difference is of relevance because there may be scope for
        supervisory authorities to make greater use of the market mechanisms which exist in relation to
        credit ratings. Also, downgradings in credit ratings will act as signals to supervisors, particularly
        as financial difficulties of reinsurers may in turn result in difficulties for insurers, with
        consequent implications for the protection of policyholders.




                                                                                                    12
2.6     Other methods of risk transfer
        Other methods of risk transfer include the following:

        § Securitisation of the risk

        § Derivatives

        § Financial reinsurance

        Global Reinsurance magazine in its June 2000 issue described Alternative Risk Transfer (ART)
        as a creative approach to funding the predicted losses in a risk area. There is however no
        generally accepted definition of ART.

        ART arrangements usually include a substantial retention level by the reinsured, with only a
        partial transfer of risk that includes elements of a traditional reinsurance contract. Some ART
        products are essentially a form of deferred lending, and most include a financing element of
        some kind. ART programmes include a variety of mechanisms such as:

        § large deductible programmes;

        § self-insured retention programmes;

        § individual and group self-insurance;

        § captive insurance companies;

        § risk retention and purchasing groups; and

        § finite risk and integrated insurance programmes.

        The importance of ART products is likely to increase, particularly in view of the contracting
        market for retrocession and the increasing involvement of investment banks in alternative
        solutions. ART solutions are driven by a number of factors and often some form of arbitrage
        may be involved, whether connected with accounting, taxation or regulation, or a combination
        of factors.

        There is generally little transparency in the accounting of ART products, and this can make it
        difficult for regulators to understand the true effects of transactions and the motivational factors
        underlying them. It is essential for supervisors to understand the commercial effects and
        substance of transactions. Understanding the amount of credit risk assumed by the reinsurer is
        also important.

2.6.1.1 Securitisation
        Securitisation is a process where the risk is transferred through a Special Purpose Vehicle
        (“SPV”) and swapped into bonds. In this case, bond holders themselves act as “         reinsurers” to
        the risk. Thus, capital markets can also act as “reinsurers” in the process of risk transfer.

        Some reinsurers invest in such bonds themselves, in order to derive a further return from
        underwriting with enhanced interest rates.




                                                                                                    13
        Commonly, the SPV is established in an offshore location, and this in itself may be a source of
        regulatory arbitrage. A number of investment banks have established reinsurance vehicles in
        such locations, particularly Bermuda. Reinsurers themselves have begun to invest in bonds
        issued by such vehicles as a means of increasing investment returns, and this results in insurance
        risk appearing on the assets side of the reinsurers’ balance sheet, in addition to its liabilities.3

2.6.1.2 Financial reinsurance
        Pure financial reinsurance contracts, with little or no transfer of insurance risk, have ceased to
        be effective in most major jurisdictions due to accounting and regulatory constraints. However,
        finite risk solutions, in which a limited transfer of underwriting risk takes place, have become
        more common.

        Products which combine underwriting risk transfer with financial elements can provide direct
        insurers with significant benefits. In a single reinsurance programme, insurers can obtain multi-
        year and multi-line cover, and benefit from reduced rates and transaction costs. With this type of
        package it is also possible for insurers to include risks which have traditionally been considered
        uninsurable (such as political and financial markets risks). Such products may have an impact
        upon cyclical trends in the insurance markets, by tying in rates for a number of years and
        establishing long term relationships between reinsurers and their clients, facilitating insurers’
        access to the capital of reinsurers.

        Financial reinsurance is sometimes seen as an effective means of “regulatory arbitrage”. An
        example can be a financial guarantee contract involving risk transfer, which in its purest form is
        a mechanism to access capital markets through insurance markets rather than banking markets.
        The motivation for the development of these products, which often take the form of financial
        guarantee insurance contracts, is the relative advantage in regulatory assessment for solvency
        calculations under insurance contracts rather than banking contracts.

        As “Reinsurance” magazine, in its September 2000 edition, pointed out, “in recent times there
        has been a marked increase in financial guarantee insurances that compete directly with the
        bank guarantees and standby letters of credit that have been a substantial area of business for
        banks. The likelihood is that increasing market share will pass to insurance companies because
        of the pricing advantage enjoyed by insurers as a result of their different regulatory costs”.

        However, there is another school of thought which suggests that insurers and reinsurers are not
        adequately pricing these risks. In particular, some are of the view that the models used by
        insurers to price such risks are not always as sophisticated as those used by banks (although
        ‘monoline’ insurers often do use sophisticated modelling techniques). It is not clear to what
        extent the competitive advantage gained by insurers is as a result of potentially lower costs of
        regulatory capital.




        3
            The Tillinghast report provides details of the special features of the regulatory aspects of
            securitisations




                                                                                                           14
2.6.1.3 Derivatives
        Derivatives in themselves are “derived” from a particular product and provide protection against
        adverse movements in the product exposure. Examples of derivative products, which are similar
        to products offered by the insurance industry, include “weather derivatives” which provide
        protection against possible climate changes that could result in natural calamities. These
        products are primarily offered by Banks.

        Like securitisations, derivatives can be obtained by reinsurers in connection with their
        investment and underwriting activities in order to increase investment income. Derivative
        transactions can result in assets and /or liabilities, and the important point is that the risk profile
        of the reinsurer’s assets can be significantly affected.

2.7     Preliminary conclusions
        Insurance and reinsurance are both designed to achieve the same basic objective: a transfer of
        insurance risk in return for a premium. Although the objectives are the same, there are some key
        differences which are of relevance to prudential supervisors:

        § the greater complexity of reinsurance business;

        § greater volatility of reinsurance;

        § the (increasingly) global nature of reinsurance business; and

        § the fact that reinsurance is transacted in the professional marketplace and there is no direct
          relationship with policyholders of insurers.

        The broad similarities between reinsurance and insurance lead to common regulatory
        approaches in many territories, but the differences are significant. In particular, the greater
        potential for volatility in reinsurance business (especially higher levels of excess of loss
        business) leads to greater uncertainty in the outcome of contracts and, ultimately, the potential
        for reinsurers to encounter financial difficulties and insolvency might be greater. Volatility will
        be lesser for a reinsurer which allows for better diversification and pooling of individual risks
        within a larger or well structured portfolio.

        Reinsurance companies are professional market players. There is usually no direct link between
        reinsurance companies and the policyholders.

        Primary insurers are usually able to pursue marketing and risk selection strategies that enable
        them to obtain homogeneity of risks in their portfolios of business. They are able to maximise
        the pooling effect of a large portfolio of risks, reducing the risk of random deviations from the
        mean value. For reinsurers, this effect is usually present to a lesser extent and the risk of random
        deviation is usually more significant.

        However, the reinsurance marketplace is a professional one, in which ceding companies
        generally have the ability to assess the claims paying ability of their reinsurers. Nevertheless,
        despite the expertise of the participants in the market, it has not been unknown for reinsurance
        companies to face financial difficulties, or for insolvencies to occur.




                                                                                                      15
3       Reinsurance and risk

3.1     Scope
        In accordance with the Terms of Reference, the objective of this chapter is to “identify the main
        types of risks that a reinsurance undertaking is exposed to (including systematic risks in the
        reinsurance sector) and make an assessment of the general importance of the different risks”.

3.2     Approach
        In reporting on the above objective, we undertook the following approach:

        § use of existing specialist knowledge;

        § use of questionnaires to KPMG offices and a limited number of interviews with reinsurers;
          and

        § reviews of existing published sources.

3.3     Risks
        The risks of reinsurance business can be considered at the following levels:

        § risks specific to the individual reinsurance undertaking;

        § systematic risk faced by the reinsurance industry; and

        § systemic risk faced by the local / global economy.

3.3.1   Risks specific to the individual reinsurance undertaking
        The risks faced by the individual reinsurers are similar to those faced by insurers, but the
        weighting and importance of the various risks impacting on an individual reinsurer depend on
        many factors, including:

        § classes of business underwritten and geographical coverage, which will affect the nature and
          severity of losses and the length of tail for claims development;

        § types of contract underwritten (for example “losses occurring” contracts compared to “risks
          incepting” or “claims made” contracts, proportional compared to non-proportional treaty,
          conventional risk transfer compared to alternative risk transfer, etc);

        § the underwriting philosophy of the reinsurer;

        § the retention policy and the retrocession programme.

        A summary of the main risks facing a reinsurance undertaking is set out below.




                                                                                                16
3.3.1.1 Underwriting risk
        The fundamental risk associated with reinsurance business is that the actual cost of claims
        arising from reinsurance contracts will differ from the amounts expected to arise when the
        contracts were priced and entered into. The key risk is that the reinsurer has either received too
        little premium for the risks it has agreed to underwrite and hence has not enough funds to invest
        and pay claims, or that claims are in excess of those projected4 . This could occur for the
        following reasons:

        1.     Risk of mis-estimation: the expectations regarding losses are based on an inadequate
               knowledge of the loss distribution, or the underlying assumptions are erroneous. This can
               be due, for example, to sampling errors, or lack of experience with new insurance risks.
               This risk can be mitigated, to some extent, by diversification of risks.

        2.     Risk of random deviation: expected losses deviate adversely due to a random increase in
               the frequency and/or severity of claims or because losses fluctuate around their mean.
               Reasons for this kind of deviation are, for example, that one event triggers multiple losses
               (accumulation, for example, in the case of natural catastrophes); or a loss experience
               triggers other events (for example, contagious diseases in health insurance or a fire which
               affects neighbouring industrial properties leading to business interruption claims). The
               significance of this type of risk in a portfolio depends on various factors, such as the
               number of risks involved, the distribution of probabilities of incurrence of claims and
               probable maximum losses. This risk is systematically decreased by the pooling approach,
               that is, assembling as many homogenous and independent risks as possible in the
               portfolio (pool).

        3.     Risk of change: adverse deviation of expected losses due to the unpredictable changes in
               risk factors that have brought about an increase in the frequency and/or severity of losses
               or payment patterns (for example, changing legislation, changing technology, changing
               social and demographic factors, changes in climate and weather patterns). Again,
               diversification of the reinsurer’s portfolio of business may contribute to the mitigation of
               this type of risk.

        4.     Reserving (provisioning) risk: In addition to the insured risk itself, there is a derived risk
               caused by the reserving process of the insurer. This is the risk that technical provisions are
               insufficient to meet the liabilities of the reinsurance undertaking (reserve risk). If
               sufficient data on historical claims development is available, this risk may, to a limited
               extent, be mitigated by proper actuarial estimation of the provisions for claims incurred
               but not reported (IBNR) and those incurred but not enough reported (IBNER). The risk
               can rarely be completely extinguished, even where sophisticated actuarial estimation
               methods are used, due to the inherent uncertainties of insurance (and reinsurance)
               business.




        4
             Babbel, D. / Santomero, A.: Risk Management by Insurers: An Analysis of the Process, in: Wharton
             Financial Institutions Center Research Papers, No. 96-16, 1996.




                                                                                                      17
        As reinsurance is essentially a form of “insurance” the key risk facing reinsurers is driven by the
        quality of underwriting. The underwriting risk is therefore exposed to the following factors:

        § competence and expertise of underwriters;

        § level of underwriting control and the quality of information available to underwrite risks; and

        § nature of the risks underwritten.

        The extent of exposure is therefore driven by the level of control exercised in accepting risks
        suitable to the company. Poor underwriting from a lack of knowledge of the underlying risks
        could have severe impacts on the resulting claims profile. This can be a particular problem when
        entering new lines of business. Proper management of underwriting exposure is therefore key.
        This includes the need to maintain effective expertise and knowledge of the areas which can
        impact upon the reinsurer’s business.

        This risk category does not include the risks arising from management override. This includes,
        for example, the risk that management overrides the pricing process in order to charge
        premiums that have been consciously calculated in order to gain market share.

        In addition to the risk resulting from inadequate or incomplete information there is a risk
        resulting from the use of false information obtained from fraudulent cedants. The correctness of
        the reinsurer’s risk assessments depends significantly on information provided by cedants.
        However, since reinsurance is a professional market with relatively few reinsurance companies
        involved, fraudulent behaviour of one cedant, when detected, will rapidly be known within the
        industry and result in the exclusion of this cedant from the market. On the other hand, the higher
        the underwriting risk the more careful reinsurers will be in assessing information received by
        cedants. Nevertheless, fraudulent actions of cedants is a risk that in principle exists in the
        reinsurance market.

        Underwriting risk is unique to insurance and reinsurance business. Reinsurers tend to manage
        risk by pooling and, for unique risks, diversification. Pooling is easier to achieve for a larger
        reinsurer than a smaller one. However, reinsurers do tend to accumulate risks, and it is quite
        possible, even for a large reinsurer, to build up accumulations of exposure in particular
        geographical regions, with consequential significant exposure to catastrophes in those regions.

        The reinsurers’ approach of managing risk by pooling, and diversification, is in contrast to the
        traditional approach to risk in banking, banks tend to manage risk by hedging. This has
        implications for reinsurers as they begin to enter into an increasing number of ART transactions
        with investment banks.

3.3.1.2 Retrocessions
        The risk management techniques employed by the reinsurer itself play a critical role in the
        sustainability and solvency of the business. A key part of this process includes the purchase of
        adequate reinsurance protection (known as retrocession).

        The extent and quality of retrocession purchased will establish the level of protection available
        to the reinsurer. The purchase of insufficient cover can lead to financial difficulties in the event
        of major unexpected claims. Accordingly, the risk of an inadequate retrocession programme
        should be recognised as a key risk.




                                                                                                   18
        It is typical for reinsurance to split up large and unique risks and to distribute the risks on the
        international reinsurance market. This allows cover to be obtained even for risks which are too
        large for the largest individual reinsurers. Such risks are shared by many reinsurers.

3.3.1.3 Credit risk
        The use of retrocession as a key part of the reinsurer’s risk management process creates a
        significant level of credit risk that amounts due under a retrocession contract are not fully
        collectible owing to insolvency. Underlying the process of retrocession is the essential need for
        the financial stability of the retrocessionaires. In particular, the reinsurer usually makes a
        significant upfront payment of premium in the hope of future recoveries when it settles claims.
        The time period which elapses between the payment of premium and claims recovery can be
        significant, particularly where long tail business is concerned.

        Consequently, the management of credit risk is of critical importance, particularly in placing
        retrocession cover. In addition, there is also some risk that the failure of intermediaries could
        result in bad debts.

3.3.1.4 Investment risk
        Investment risks affect the assets of a reinsurance undertaking. A major element of investment
        risk is market risk. This includes the risks of asset and liability value changes associated with
        systematic (market) factors. Some forms of market risk relating to investment risk are, for
        example, variations in the general level of interest rates and basis risk (the risk that yields on
        instruments of varying credit quality, liquidity, and maturity do not move together)..

        Other risks that have to be considered in relation to investments of a reinsurance undertaking are
        the default risk / credit risk, call risk, prepayment risk, extension risk, convertibility, real estate
        risk and equity risk.

        Investment risks can result in:

        §   lower investment yields than expected when pricing insurance contracts due to a changing
            capital market environment (for example, changing interest rates, changing currency rates,
            adverse development of borrowers credit rating with respect to interest payments on a
            bond);

        §   asset losses (for example, due to a decrease in the value of equity investments as a result of
            systematic risk or as a result of the performance of the issuing company); and

        §   cash-flow risks (for example, reinsurers operate in markets where they may receive
            clustered claims due to natural catastrophes. Their assets, however, are sometimes less
            liquid, particularly where they invest in private placements and real estate).

        The area of investment risk will be investigated further in the insurance solvency study 5 .




        5
            A KPMG study commissioned by Internal Market Directorate General of the European Commission:
            “Study into the methodologies to assess the overall financial position of an insurance undertaking
            from the perspective of prudential supervision” (2002).




                                                                                                      19
3.3.1.5 Globalised risk portfolios
        As described in chapter 2, reinsurance is a globalised market whereby reinsurers accept risks
        from different parts of the world. Although this can be an effective risk diversification strategy,
        it can also result in adverse impacts being felt from distant geographical regions. Thus, many
        reinsurers can be exposed to a “high profile disaster” irrespective of their geographical origin.

3.3.1.6 Currency risk
        Strongly related to the globalised portfolio is currency risk. Most reinsurers write business in a
        number of currencies. As a result of an international risk portfolio, reinsurers usually need to
        invest in equivalent currency assets to match the liabilities. Reinsurers are therefore exposed to
        a certain level of currency risk arising from the spread of investments in different currencies.
        Currency matching is not always achievable, due to uncertainties in cash flows and the
        influence of accounting principles and practices. Also, it may not always be desirable to hold
        assets in certain currencies, where the currency of liabilities is weak. In addition, foreign
        exchange control restrictions may limit the extent to which liabilities in certain currencies can
        be matched by assets in the same currency.

3.3.1.7 Timing Risk
        Timing risk is interrelated with both underwriting risk and investment risk. The extent to which
        investment returns contribute to the profitability of an insurance portfolio depends both on the
        investment yield (influenced by investment risk) and the speed of settlement (which can be
        affected by underwriting risk, especially by unpredictable changes in risk factors). An increase
        in the speed of claims settlement reduces return on investment 6 . Investments need to be
        matched, in terms of their maturity, with the expected settlement of claims liabilities.

        Timing risk can be fundamental in financial contracts. Some financial contracts involve limited
        transfer of underwriting risk but nevertheless include timing risk.

3.3.2   Systematic risk
        Systematic risk is defined as risk which affects the entire industry. A discussion of some of the
        risks is given below.

3.3.2.1 Market pricing trends
        The reinsurance industry appears to undergo pricing cycles with periods of high and low prices.
        In addition (as noted by the IAIS Reinsurance Working Group), the price of catastrophe
        reinsurance is strongly influenced by the laws of supply and demand. However, when market
        conditions are soft (rates are low and reinsurers do not have the power to obtain the increases
        they desire), it is not uncommon for reinsurers to continue writing business at uneconomic rates.
        There may be various reasons for this, but the principal reason is competition: the desire to
        retain clients and maintain market share.

        Low price cycles can be very damaging to the industry as they leave smaller reinsurance players
        with the exposure of meeting claims with inadequate premium flow. In these circumstances, a
        huge natural disaster could trigger potential insolvencies.




                                                                                                  20
3.3.2.2 Interaction of insurance and reinsurance markets
        As the reinsurance market is driven by claims development in the insurance sector, any
        significant developments in the insurance industry are likely to lead to losses in the reinsurance
        industry. In terms of claims development, an example is the sudden surge in asbestosis claims
        which has recently been recognised in the insurance industry and consequently the reinsurance
        industry.

        Other examples of insurance industry trends which have also affected the reinsurance industry
        include:

        § increasing costs of litigation;

        § legal rulings which affect large numbers of claims;

        § improvements in medical technology leading to better chances of surviving accidents but
          leading to higher incidence of “loss of earnings” claims; and

        § smaller players in the market following the actions of larger players.

3.3.2.3 Failure of a major reinsurer
        The financial failure of a large reinsurance player may have consequences within the overall
        reinsurance and insurance sector, due to the sheer dominance of the global market by the largest
        reinsurers. As a result of the complex spreading of risks around the market, failure of a large
        reinsurer to meet its obligations can have an impact across the market, both for other reinsurers
        and for primary insurers. In fact there have been until now no significant breakdowns of a
        reinsurance company.

3.4     Systemic risks
        In contrast to systematic risk which is limited to a particular industry, systemic risk is defined as
        the risk which arises in relation to the entire economy (local or global). It is a general risk
        affecting every market participant. Therefore, the insurance and reinsurance industry are
        affected as well. Relevant factors include:

        §   economic cycles (for example, recessions lead to a downward cycle in the insurance
            industry as demand for insurance products, and consequently for reinsurance, falls, but
            higher unemployment leads to an increase in theft related claims);

        §   political instability: the level of political stability affects the overall performance of the
            economy, which is an important factor in wealth creation. Insurance (and reinsurance) is
            likely to see higher demand under more wealthy economic conditions. Also, international
            business can be affected by capital transfer restrictions;

        §   interest rate movements (affecting the returns gained from investments which are primarily
            bond based for reinsurance companies); and

        §   collapse of the financial sector (due to insolvencies of large banks or insurance companies
            leading to a possible economic slowdown).

        6
            Carter, R. / Lucas, L. / Ralph, N.: Reinsurance, 4th Ed., 2000 , p. 735




                                                                                                    21
3.5     Assessing the importance of different risks
3.5.1   Risk matrix for reinsurance
        The table below provides a risk matrix for reinsurance. This has been constructed based on the
        identified “activities” of a reinsurer. Against each activity, the relevant risks have been
        mentioned in order of importance. For the risks mentioned, further analysis is provided on the
        components of these risks, the factors triggering the risks and common mitigation strategies.

        It has to be noted that this is only a snapshot, and does not necessarily reveal the impacts of
        sophisticated reinsurance strategies on risk profiles. Furthermore, this snapshot does not
        examine the impact of special market environments on the risk profile; traditional one year
        contracts are not exposed to heavy risks resulting from the change of risk factors (see actuarial /
        underwriting risk), but, due to soft reinsurance markets in the past, many reinsurance companies
        were forced to sell traditional one year contracts featuring multi-year characteristics.

        Reinsurance Risk Matrix

         Activities        Risks             Risk          Factors triggering         Mitigation Strategies
                                         Component                 Risk
        Reinsurance    Underwriting    Random            Class of insurance,        Pooling; retrocession
        Non-life –                     fluctuation       type of reinsurance
        proportional                   (especially       treaty, limits on treaty
                                       surplus treaty)   capacity
                                       Random            Class of insurance,        Exclusions or event or
                                       fluctuation       limits in treaty           cession limits
                                       (natural peril    capacity
                                       losses)
                                       Erroneous         Lax underwriting by        Adjustment of reinsurance
                                       assumptions       ceding company,            commission (i.e. sliding
                                       made by cedant    cedant’s experience in     scales), non-proportional
                                                         the respective market,     cover, use of cession limits
                                                         market environment         experience in the
                                                         (competition),             respective insurance
                                                         reinsurer’s liability      market, diversification
                       Credit Risk     Cedant’s credit   Payment patterns           Monitoring of cedant,
                                       rating                                       deposits
        Non-life –     Underwriting    Erroneous         Class of insurance,        Retrocession, diligent
        non-                           assumptions       market experience,         pricing process, use of
        proportional                                     accumulation of            underwriting guidelines,
                                                         losses, cedant’s           diversification
                                                         retention, reinsurer’s
                                                         liability, reinsurer’s
                                                         profit loading
                                                         Profit sharing             Use of adjustable
                                                                                    premiums experience on
                                                                                    the respective insurance
                                                                                    market
                                       Fluctuation in    Class of business          Pooling, retrocession
                                       loss experience
                       Credit Risk     Cedant’s credit   Payment patterns           Monitoring of cedant,
                                       rating                                       deposits




                                                                                                      22
 Activities       Risks             Risk            Factors triggering     Mitigation Strategies
                                Component                  Risk
Reinsurance    Underwriting   Changes in risk     Mortality/morbidity    Diversification,
Life –                        factors             experience, early      retrocession
proportional                                      cancellation/lapse
                                                  probabilities
                              Erroneous           Adverse selection by   Quota share treaties
                              assumptions         ceding company,        retrocession
                              (esp. surplus       accumulation of
                              treaty)             losses
                              Random              War                    Exclusion
                              fluctuation in
                              loss experience
                              Random              Contagious disease     Pooling; retrocession
                              fluctuation in
                              loss experience
               Investment     Interest rate       Bonus declaration      Reinsurer uses investment
               Risk           risk, market        details                diversification strategies;
                              risk, credit risk   Wide range of market   matching assets and
                                                  factors                liabilities
Life – non-    Underwriting   Erroneous           Class of insurance,    Support by health
proportional                  assumptions         market experience,     examination
                                                  accumulation of
                                                  losses
                              Changes in risk     Mortality experience   Diversification,
                              factors                                    retrocession
                              Random              War                    Exclusion
                              fluctuation on
                              loss experience
                              Random              Contagious disease     Pooling, retrocession
                              fluctuation on
                              loss experience




                                                                                            23
          Activities         Risks             Risk           Factors triggering        Mitigation Strategies
                                           Component                Risk
        ART/Fin Re       Credit Risk     Cedant’s credit     Payment patterns         Monitoring of cedant
                                         rating
                         Investment      Interest risks on
                         Risk            Long-Tail
                                         classes of
                                         business
                         Other Risk      Business not
                                         admitted for tax
                                         or supervisory
                                         purposes
        Investments      Investment      Fluctuation in                               Diversified investment
                         Risk            equity prices,                               portfolio, asset-liability
                                         fluctuation in                               matching
                                         interest rates
                         Credit Risk     Cedant’s            Delays in the            Monitoring of cedant,
                                         diligence/credit    accounting for and the   established business
                                         rating              remittance of            relations with cedant
                                                             premiums by cedant
                                         Debtor default      Debtor’s financial
                                                             rating
        All activities   Exchange        Fluctuations in                              Asset – Liability
                         Rate Risk       exchange rates                               matching/Hedging
                         Country         Changing                                     Regional diversification,
                         Related Risks   economic                                     regional expertise
                                         environment,                                 underwriting guidelines
                                         legal, tax, and
                                         regulatory
                                         environment,
                                         declining
                                         growth,
                                         inflation, war


3.5.2   Proportional versus non-proportional contracts

3.5.2.1 Diversification
        The reinsurer is exposed to different risk profiles depending on the type of treaty reinsurance
        business it writes. In the case of proportional reinsurance contracts, the reinsurer essentially
        participates in the same risks as the ceding insurance company. Its risk profile is therefore very
        similar to the ceding company.

        In contrast, by writing a non-proportional contract the reinsurance company generally
        participates only in high exposure risks, in excess of the stated retention limits. However, whilst
        writing a non-proportional contract, the company is exposed to a higher risk of random
        deviation of loss occurrence from its mean that does not necessarily result in a higher mean risk
        exposure for the reinsurer, as compared to writing proportional contracts.




                                                                                                          24
        This is due to the pooling effects from writing other non-proportional contracts. The overall
        exposure to fluctuations in the loss experience is likely to be reduced when looking at the
        overall portfolio compared to a single contract. Therefore, the risk profile of a reinsurer depends
        on the size of the total portfolio, with the risk of random fluctuations in loss experience likely to
        decrease with the increasing size of the reinsurance portfolio. Geographical and risk type
        diversification can also be achieved in addition to the pooling achieved within a portfolio of
        risks. Geographical diversification is more common in reinsurance companies, because
        reinsurance companies generally do business on a more international basis than insurance
        companies.

3.5.2.2 Structure of contract

        The risk profile of a particular reinsurer will be significantly affected by the terms and
        conditions of the business it writes. In particular, the future claims profile is likely to be
        influenced by the retention levels, restrictions and exclusion clauses contained in a treaty. A
        proportional contract with a high retention by the cedant also exposes the reinsurer to high
        severity losses rather than to high volume losses, resulting in a potentially higher volatility of
        results compared to a contract with a lower retention.

3.5.2.3 Premium Structure
        A reinsurer may write a contract with a high premium combined with a profit sharing
        agreement. In this situation it is more likely that the reinsurer is prepared for unexpected loss
        development compared to writing a contract without a profit sharing agreement (and therefore a
        relatively lower premium). Similar effects can be achieved by using sliding-scale commission
        rates. The reinsurer can reward a ceding company for ceding profitable business and conversely
        penalise it for poor experience, giving the cedant an incentive to cede high quality business.

3.5.2.4 Information asymmetry
        For non-proportional contracts the risk of mis-estimation might be considered to be more
        important than for proportional contracts, since information asymmetry is potentially more
        likely between the insurer and the reinsurer with respect to the characteristics of the original
        business written and past loss experience. Under proportional cover the reinsurer participates
        not only in the original losses but also in the original premium, and can rely to a greater extent
        on the underwriting experience of the ceding company.

3.5.3   Life and health contracts
        Life business is especially exposed to the risk of change with respect to the parameters used in
        pricing, such as mortality and morbidity assumptions. The higher exposure to the risk of mis-
        estimation is related to the longer term of life (re)insurance contracts compared to non-life
        contracts. For the same reason and due to the savings component being more important than
        with non-life contracts, life contracts in general involve higher investment risk than non-life
        contracts.




                                                                                                    25
        Additional risks for insurance and reinsurance companies can emerge from the privatisation of
        traditional social security systems, for example health insurance, workers’ compensation and
        disability insurance, pension benefits etc, that can be noted in several European countries.
        Reinsurance companies might be tempted to write such business in consideration of its pure
        volume. As a result, they may under-estimate the administration effort and policyholders
        expectations with respect to benefits related to this business (this reflects expense risk: the risk
        that expense levels associated with administering policies may in practice be different to those
        originally expected, in writing the business).

        Due to the longer term nature of the contracts, further risks arise for example from economic
        cycles. Economic downswings might trigger increased payments relating, for example, to
        disability insurance with employees preferring to try to qualify for disability benefits over
        unemployment benefits. Due to the reinsurer having to rely on the insurer to submit information
        on changing loss experiences and increases in payments and/or reserves, the risk for the
        reinsurer relating to all kinds of changes is more important than for the insurer, because in
        addition to the risk of change the reinsurer is exposed to the risk of untimely reporting by the
        insurer.

        Non-proportional life reassurance contracts are related mostly to coverage of low probability
        insured events such as death, with high sums assured. The reassurer relies heavily on the risk
        selection and health examination processes of the insurer but often has the ability to influence
        this. The reduction of risk of random deviation is normally achieved by pooling and retrocession
        of sums assured.

        Proportional reassurance in life business normally involves the transfer of the original insurance
        risk and a significant financing element, relieving the solvency and cash flow strains associated
        with the acquisition of new business by the primary insurer. Proportional treaties are also used
        where the reassurer effectively underwrites the business but uses the primary insurer in a
        territory where it is not licensed to write the direct business, or does not have the administrative
        capabilities to do so. In such cases insurance risk will be present, and life insurers may use
        proportional reinsurance to transfer unknown elements of risk (such as the emergence of dread
        disease). Proportional business often includes a significant profit share element.

3.5.4   Property / casualty contracts
        Property reinsurance contracts are especially exposed to random fluctuations in loss experience,
        especially where high levels of catastrophe cover are provided. While this risk is dominant with
        non-proportional contracts (see explanation above), it also exists with proportional contracts.

        The dominant risk related to casualty reinsurance contracts is the risk of mis-estimation. This
        risk increases in long-tail lines of business, where significant claims can emerge after a
        considerable lapse of time since the policy was originally underwritten (depending on the type
        of policy). For reinsurance companies this risk is exacerbated, because of the additional risk of
        untimely reporting by the insurance company.




                                                                                                   26
        Reserve/provision risk can be particularly important for non-proportional contracts. Here the
        reinsurer is exposed to the risk of a failure in the loss reserving practice of the ceding company.
        If the claims department of the ceding company does not set up loss reserves for single claims in
        an accurate manner, the reinsurance company is exposed to the risk of not receiving notice of a
        claim in a timely manner, especially if the contract covers new business, where extensive
        historical data on past loss experience is unavailable and the calculation of the IBNR/IBNER
        reserves is therefore difficult.

3.5.5   Alternative risk transfer (ART) products
        Most ART products do not transfer as much insurance risk as traditional reinsurance products.
        Credit risk is likely to be of greater importance due to a substantial financing element in such
        contracts. A reinsurer could incur significant losses if the cedant is unable to repay the financing
        element of the contract. Underwriting risk tends to be less important in these contracts and in
        many cases the reinsurer is not exposed to significant risk.

        It should be noted that ART is still an emerging area. Although financial contracts have been
        present in the reinsurance and insurance industries for many years, new products have begun to
        emerge in recent years which are increasingly complex and involve a new approach to risk
        management for many reinsurers. Accordingly, some reinsurers view such developments with a
        degree of caution, but nevertheless, ART appears set to continue to be a growth area.

3.6     Conclusion
        Risks facing the reinsurance industry are based on many variables. The variability and their
        different weighting is the main reason for the relative complexity of this industry. The size of
        the reinsurer can also play a part in determining the risk profile. Larger undertakings generally
        tend to be more diversified in their risk portfolio and are better placed to absorb unexpected
        fluctuations in claims.

        As a result, reinsurance supervisors are faced with a range of risk factors that they must be
        familiar with in order to appreciate the risk exposure of an individual company. It is clear that
        there are wider macro risks which affect the reinsurance industry as opposed to relatively micro
        risks affecting the insurance industry. A significant issue for supervisors is that, given the global
        nature of the business, there is a need for understanding of the macro issues and this requires
        international information sharing and a wider knowledge base than can be obtained by focussing
        on individual states alone.

        Due to the remoteness from the original insured risks, the risk of error in the recording of claims
        is of relatively greater importance for reinsurers than for insurers. This is the risk that claims
        provisions established initially may subsequently prove to be inadequate, and this has
        implications for the reinsurer’s capital at risk, its solvency position, its retrocession programme,
        and pricing. Risk of random fluctuations caused by the inherent volatility of the business
        (especially catastrophe excess of loss business) is also of major importance, although such risks
        can be reduced by effective risk management in large, well diversified and structured portfolios.
        The increasing advent of ART solutions leads to the increasing importance of credit risk relative
        to underwriting risk. Currency risk can also be a major factor in a reinsurer’s risk profile,
        depending on the geographical spread of assets and liabilities.




                                                                                                   27
4     Description of the global reinsurance market

4.1   Scope
      In accordance with the Terms of Reference, this chapter provides “a description of the global
      reinsurance market, covering in particular the following items: the main market players
      (including captives), their broad market share and the jurisdictions in which they are located,
      the role of offshore locations, the major reinsurance products, the likely future evolution of the
      market and developments in products, the trend from proportional to non-proportional
      business, the advent of ART (“alternative risk transfer”) and securitisation, convergence
      between reinsurance and investment banking activities, the competitive position of EU
      reinsurers from a global perspective. The study should also identify possible discriminations in
      some countries concerning reinsurers based in certain other countries, as well as analyse
      existing barriers to cross-border reinsurance”.

4.2   Approach
      In reporting on the above objective, we undertook the following approach:

      § Use of existing specialist knowledge;

      § Use of questionnaires to KPMG specialists in major reinsurance markets, to be further
        followed up by discussions with market participants where necessary; and

      § Review and analysis of existing published material.

4.3   The global reinsurance market
      In 1999 direct insurers ceded business worth US$ 125 billion to reinsurers worldwide
      (“Reinsurance”, August 2000). The market has remained relatively flat since 1998, due to
      various factors, including consolidation in the primary insurance industry and the general low
      inflationary environment. Soft conditions in the market have also limited growth, as reinsurers
      have lacked the power to increase rates. In such conditions, an increased use of proportional
      cover has been noted over the past two years, as reinsurers have sacrificed quality in
      underwriting in order to retain their key clients, whose portfolios may be under performing the
      market.7

      A study prepared by “Reinsurance” magazine (August 2000) of 1999´s top 100 reinsurance
      companies showed that in 1999 the reinsurance companies made an average underwriting loss
      of 11% on their net written premiums. Reinsurance business is relying on substantial returns
      from investments rather than underwriting income to contribute to profits. Although of the 87
      companies reporting underwriting results, 72 made an underwriting loss, only 18 out of 85 (that
      provided pre-tax results) recorded an overall pre-tax loss.

      The same study reveals that 33% of the premiums written by the world’s top 100 reinsurance
      companies were written by the top five in 1999 (1998: 37%), and almost half (48%, 1998: 50%)
      were written by the top ten.


      7
          Noted by Standard & Poor’s in their Global Reinsurance Highlights 2000 edition




                                                                                               28
Big companies, despite underwriting losses, continue to dominate the reinsurance market. The
top ten reinsurance groups, as identified by market share (ranked by net written premiums) are
as follows:

    Reinsurer            Primary jurisdiction       Total Net premiums written   Combined
                                                    (US $ million)               ratio (%)

    Munich Re            Germany                               13,566            118.9

    Swiss Re             Switzerland                           12,839            116.0

    Berkshire Hathaway   USA                                   9,453             116.3

    ERC                  USA                                   6,921             114.0

    Gerling Group        Germany                               3,938             114.0

    Lloyd’s              United Kingdom                        3,799             N/A

    ASS Generali         Italy                                 3,533             113.5

    Allianz Re           Germany                               3,299             107.4

    SCOR Re              France                                2,721             109.7

    Hannover Re          Germany                               2,564             95.9

    Source: Standard & Poor’s Global Reinsurance Highlights (2000 edition)



The trend towards concentration is frequently noted, but it has become more accentuated since
the mid 1990s. The effect of concentration is that reinsurers themselves are obliged to grow
through the absorption of some of their competitors. Also, as risks are becoming increasingly
sophisticated, smaller or medium sized reinsurers are not always able to meet the increasingly
complex needs of their clients. 8

Industry consolidation: recent mergers and acquisitions

1995 was the first of several years of significant mergers and acquisitions. As noted in Global
Reinsurance9 , “General Re acquired Cologne Re and ERC bid for Munich based Frankona. The
following year, Munich Re bought American Re and Swiss Re acquired the Mercantile &
General, from the Prudential and Unione Italiana.”

“In Bermuda, ACE bought property-catastrophe reinsurer, Tempest, followed by CAT Ltd. For
its part, XL added the property-catastrophe reinsurer, Global Capital Re, to its portfolio, and
later took control of Mid Ocean Re.”




8
      Source: As noted in Global Reinsurance, September 2000 “The French reinsurance market 1999”
9
      Source: Global reinsurance – Dec 1999 “Ten years in Reinsurance”




                                                                                             29
        “In 1997 and 1998, the process continued. The largest of the Bermuda property-catastrophe
        reinsurers, PartnerRe bought France's SAFR, and another Bermudian, Terra Nova, bought
        Corifrance. Munich Re acquired Reale Ri in Italy. Berkshire Hathaway acquired General &
        Cologne Re, and ERC bought the US companies, Industrial Risk Insurers and Kemper Re, plus
        the UK's Eagle Star Re. Further moves followed in 1999, XL, now XL Capital, took over the
        US company NAC Re. More recently US insurer Markel agreed to buy Bermuda's Terra Nova.”

        During the 1990s, the number of reinsurance companies worldwide has decreased and business
        has become significantly more concentrated. For example, between 1990 and 1996 the number
        of US professional reinsurers fell from 130 to 41. In 1990, the five largest reinsurers were
        estimated to control 21% of the world non-life reinsurance market estimated at $90 billion a
        year; by the end of 1998, the five largest controlled 37% of the global market (Source: Global
        Reinsurance).

4.4     The major reinsurance products
        1999 saw the first year of growth in the global reinsurance market following three years of
        contraction. According to a study by Swiss Re, reinsurance business was split 83% non-life and
        17% life and health. Ceded premiums in relation to direct insurance volume were 14% in non-
        life and 1.5% in life and health. Life reinsurance has been a steady source of growth,
        counterbalancing some of the weaknesses in the non-life market (Sigma 9/1998).

4.4.1   Life and health
        The definition of life and health reinsurance varies, but the core business is clearly still
        protection against mortality. Other main components include guaranteeing of investment
        income and protection against morbidity and medical expenses.

        The growth in life and health reinsurance is a relatively recent trend. Unlike the volatile nature
        of catastrophe reinsurance business, life and health reinsurance provides much steadier cash
        flow and more stable results. The life sector is thought to be growing by at least 15% per
        annum. Some experts estimate the growth to be in the region of 30% 10 . Various factors lie
        behind the growth in life reinsurance.

        First, direct life assurance is increasing globally. The reason for this is that the world economy
        has experienced high growth rates in the past few years and people are investing their increased
        wealth in life insurance and investment products. Also, social security systems in highly
        advanced, mostly European, welfare states no longer have the capacity to cover the countries’
        life assurance and pensions demands.

        Secondly, direct life assurers are reinsuring a higher proportion of their business. This is not
        only for capital adequacy reasons, but also because they are focussing increasingly on their core
        strengths of distribution and asset management. By doing so, they rely on the reinsurers’ risk
        assessment expertise and innovative skills. Life assurance and reinsurance are highly technical
        and actuary-dominated. In consequence, life assurers tend to outsource their risks through
        reinsurance (that is, they outsource the management of mortality).




        10
             Source: Baylis Mark, Global Reinsurance, appendix 4, pages 1-3




                                                                                                 30
An analysis by Swiss Re, shown below, illustrates the breakdown of ceded premiums in the life
and health sector in 1997.

Regional breakdown of ceded life & health premiums 1997

                                                          Ceded premiums
                                                    In US$ billion           As a % of the total

 North America                                               10.6                          49.1
 Western Europe                                               9.1                          42.1
 Asia/Pacific                                                 0.6                           2.6
 Japan                                                        0.6                           2.8
 Latin America                                                0.6                           2.8
 Eastern Europe                                               0.2                           0.6
 Total world                                                 21.7                         100.0
 Source: Sigma 9/98



In life reinsurance, size counts. Cedants prefer trading with companies that are regarded as ultra-
secure. Smaller companies usually either have the backing of a parent or find their opportunities
restricted. The market shares of the major market players in 1997, according to Swiss Re, are
shown below.

Market shares in the life and health reinsurance market 1997


 Swiss Re                                                              19%
 Munich Re                                                             9%
 Employers Re/Frankona                                                 7%
 Cologne Re                                                            6%
 Lincoln Re                                                            5%
 Hannover Re                                                           5%
 Transamerica                                                          3%
 RGA                                                                   3%
 Manulife                                                              2%
 Other                                                                 41%
 Total                                                                100%
 Source: Sigma 9/98



Reliable market-wide figures in relation to the breakdown between proportional and non-
proportional reinsurance in life and health industry are not available. According to an estimate
in Global Reinsurance11 , 75%–80% of reinsurance is sold via quota treaties (proportional),
although there are some significant territorial variations.




11
     Source: Baylis, Mark, Global reinsurance, appendix 4, page 1-3




                                                                                             31
4.4.2   Non-life reinsurance
        Non-life reinsurance includes all classes of reinsurance other than life and health reinsurance.
        The major classes in non-life reinsurance are: property, accident (casualty), liability, motor,
        marine, engineering, nuclear energy, aviation and credit and surety.

        North America and Western Europe together account for 74% of the worldwide non-life
        reinsurance market.

        Regional breakdown of ceded non-life premiums 1997

                                                              Ceded premiums
                                                           US$ billion              As a % of the total

         North America                                           39.9                             38.9
         Western Europe                                          36.1                             35.1
         Asia/Pacific                                            12.4                             12.1
         Japan                                                    4.3                              4.2
         Latin America                                            3.3                              3.2
         Eastern Europe                                           1.7                              1.6
         Rest of the World                                        5.0                              4.9
         Total world                                            102.7                            100.0
         Source: Sigma 9/98



        The table below provides further illustration of the domination of the global market by a small
        number of major reinsurers.

        Market shares in the non-life reinsurance market 1997


         Munich Re                                                          10%
         Swiss Re                                                           8%
         General Re                                                         5%
         Employers Re                                                       5%
         Hannover Re                                                        3%
         Gerling Globale Re                                                 2%
         SCOR                                                               2%
         Zurich Re                                                          2%
         AXA Re                                                             1%
         Generali                                                           1%
         Other                                                              61%
         Total                                                             100%
         Source: Sigma 9/98



        Within the EU, non-life business is dominated by motor, accident and health, and property
        business. Factors which influence the proportion of business reinsured include the pricing and
        availability of reinsurance cover, the volatility inherent in the underlying business, and the
        degree of uncertainty involved in predicting underwriting results. Longer tail classes of
        business, and those which can be subject to catastrophic losses, are in general likely to attract
        greater levels of reinsurance protection. The table below illustrates this, with higher percentages
        reinsured in property, liability and MAT classes.




                                                                                                    32
        Breakdown of non-life business in EU and percentage of business reinsured

         Type of non-life business
                                                        As % of all non-life             Percentage reinsured

         Motor                                                 34%                            12%
         Accident & Health                                     24%                             7%
         Property                                              21%                            31%
         Liability Insurance                                    6%                            25%
         Marine, aviation & transport                           7%                            36%
         Others                                                 8%                            14%
         Total                                               100%
         Source: EU Commission, Report: Results of Questionnaire on the Supervision of Reinsurance
         Undertakings, 1999



4.4.3   Alternative risk transfer (ART) products
        Boundaries between traditional and alternative risk financing tend to blur. This, together with
        the frequent invisibility of ART products in financial statements, makes it extremely difficult to
        make quantitative statements about the market volume of the ART products. Also, a common
        basis for the business volume of ART products seems to be difficult to identify. However, a
        study produced by Swiss Re estimates the premium volume of ART products to be around US$
        30 billion, of which captives account for approximately two-thirds. Integrated multi-year/multi-
        line products, multi-trigger cover, contingent capital as well as insurance bonds and derivatives
        are still insignificant in terms of volume. (Source: Sigma 2/1999).

        The reinsurance industry tends to offer ART products, multi-line or multi-year contracts directly
        to the company that demands the insurance protection. The construction works legally either via
        fronting through the books of a direct insurer, or if possible directly with the demanding
        company.

        The size of the ART market by different product categories in 1998 has been estimated in a
        study prepared by Tillinghast Towers-Perrin. Their findings are summarized below:

        Estimated market size

                                                                                                 US$ billion

         Estimated size of worldwide ART market*                                                         13
         Estimated size of World Reinsurance Market                                                     125
         Estimated size of World Insurance Market                                                     2,129
         Estimated size of European Insurance Market                                                    669

         *excludes captives and other self-funded vehicles but including securitisation.
         Source: Tillinghast Towers-Perrin, European Commission ART Market Study, Final report October 2000


        The major markets for ART business are based in New York (estimated at more than 50% of the
        business written), Bermuda, London, Zurich, Dublin and Luxembourg. However specialist
        companies in this market also operate in other countries, such as Hannover Re in Germany.




                                                                                                              33
        The success of ART products has continued to attract further entrants to the ART market. In the
        last five or six years, many new operations have been established and there are continuing signs
        of increasing competition in this area.

        A sub-segment of the ART market is risk transfer using capital markets. Risk transference
        through capital markets is still a narrow segment compared with traditional reinsurance or
        insurance. That is mainly due to the costs and inefficiencies of the transactions for the issuer.
        Capital market solutions are focused on natural catastrophe risks. Insurance derivatives and
        securitisation have been the major mechanisms for insurance risk transfer using capital markets.

        Trading of insurance derivatives on commodities exchanges has only been modest, even though
        the instruments have been adapted and refined to meet client needs many times since they were
        first introduced. The use of insurance derivatives as protection against previously uninsured
        threats to the earnings of an industrial or service company offers a lot of potential. Weather is
        only one example.

4.4.4   The Internet as a distribution channel
        In 1999 and 2000 reinsurers’ margins were under pressure. The reinsurance industry considered
        two ways of tackling the problem: higher rates and lower transaction costs. Internet based
        reinsurance trading systems are promising lower transaction costs and faster and easier access to
        business than the traditional distribution channels. However, internet business is likely to put
        pressure on margins as well 12 .

        Based on internet technology there are currently two major systems used by reinsurance
        markets: “Reway” and “  Inreon”. Reway was set up by Gothaer Re of Germany. Inreon is
        backed by the world’s two biggest reinsurers, Swiss Re and Munich Re together with Internet
        Capital Group (US based internet holding company and Accenture)13 .

        Inreon provides insurance companies, brokers and professional reinsurers with transaction
        capabilities for standardised reinsurance covers. Inreon´s standardised reinsurance trading is
        initially on facultative non-proportional property business in the USA, UK, France, Germany,
        the Netherlands, Italy, Belgium and Spain. In the near future products will include facultative
        proportional property cover and both non-proportional and proportional covers for casualty and
        other lines of business.14

        Reway as well as Inreon offer insurance companies, brokers and professional reinsurers an
        opportunity to use the internet platform to enter into reinsurance treaties online. Reway is
        focusing initially on the European market.




        12
             Reinsurance, October 2000
        13
             Bloomberg, L.P.: Munich Re, Swiss Re ; Accenture set up internet site, 18.12.2000
        14
             Lloyd’s of London Press Limited: Two top reinsurers team up to form web-based exchange,
             19.12.2000




                                                                                                       34
4.5   The role of offshore locations
      Offshore insurance and reinsurance is often, but not always, driven by taxation and regulatory
      considerations. Whilst early offshore insurance and reinsurance companies faced few
      regulations, more recently most locations have adopted relatively comprehensive systems of
      insurance supervision and regulation. As the international significance of off-shore insurance
      and reinsurance has grown, it has been necessary to upgrade the quality of insurance regulation.
      Regulatory co-operation with the main on-shore markets is substantial, including exchange of
      information.

      Nevertheless, the generally simpler offshore legislation makes it easier to evolve new types of
      product. The favourable regulatory and taxation environment encourages innovation and
      development. Almost all of the new insurance and reinsurance approaches that have broadened
      the practical concepts of insurance have been developed offshore. Hence, offshore insurance
      and reinsurance markets in the past grew with new approaches to covering risk, such as
      financial insurance and reinsurance and the securitisation of reinsurance risks. However, growth
      in more traditional areas of insurance and reinsurance, particularly in catastrophe reinsurance
      and excess liability insurance, has also been seen in these offshore locations.

      Aside from regulatory considerations, other factors may be involved in the formation of
      insurance or reinsurance companies offshore. For example:

      § the use of independent territories to manage global insurance and reinsurance programmes
        neutrally;

      § cost effective insurance and reinsurance management by specialist companies; and

      § reducing taxation costs.

      Reasons for using an offshore location include:

      § the capability to co-ordinate global insurance programmes between reinsurance companies
        from a number of countries, often in conjunction with an overall umbrella or similar cover;

      § the ability to access other insurance and reinsurance markets without any domestic
        regulatory limitations; and

      § involvement in the reinsurance or coinsurance of captive and other offshore insurers through
        local presence.

      Recently the distinction between onshore and offshore domiciles has become somewhat blurred,
      because onshore captive locations continue to introduce legislation aimed at attracting new
      business. Various actions by the OECD have reduced the taxation benefits of offshore locations.
      However, in the case of captives the offshore market is growing faster than the onshore market.
      In 1998, two thirds of new captives formed were offshore, and the trend is continuing.

      A major attraction of offshore captive domiciles is the low level of regulation. However, many
      domiciles have recently tightened up their insurance (and reinsurance) regulations in the face of
      accusations that their regulation is somewhat lax. Nevertheless, compared with setting up in the
      parent territory of the captive, the regulatory environment can still be favourable.




                                                                                              35
      The electronic revolution removes most of the remaining barriers between the onshore and
      offshore markets. Reinsurance/insurance can therefore be transacted anywhere that has physical
      capabilities (digital communications etc) and where insurance expertise exists. This in turn
      creates a threat to traditional geographical centres of the reinsurance market15 .

      Perhaps the most significant development in offshore locations was the development of
      Bermuda as a location for reinsurance companies. Whilst the Bermudian companies have
      continued to remain strong, and have themselves seen significant consolidation, they have also
      seen the attraction of location in major onshore centres, such as the US and Europe. For
      example, ACE, XL Capital and Terra Nova have become major investors in Lloyd's.

4.6   Captives
      A captive is an insurance company that belongs to a major corporation or group and underwrites
      or reinsures primarily or exclusively the risks of firms belonging to the respective group. In
      1998, there were about 3,800 captives worldwide, creating a premium volume of approximately
      USD 21 billion16 , equivalent to a share of roughly 6% of all premiums written in commercial
      lines of business. One-third of the captives were domiciled in Bermuda. More than half of all
      captives worldwide belong to industrial and service companies in the US.

      The captive market is highly competitive in terms of captive domiciles and the competition is
      set to continue to be fierce in the future. More than 80% of the estimated total number of
      captives worldwide are located in eight major domiciles.17 :

                   1. Bermuda

                   2. The Cayman Islands

                   3. Guernsey

                   4. Vermont

                   5. Luxembourg

                   6. Barbados

                   7. The Isle of Man

                   8. Dublin

                   (for details of numbers of captives see Appendix 2)

      Whilst the captive market has been growing steadily over the last two or three decades, with net
      growth of around 200 captives each year, this growth has slowed slightly in recent years.




      15
           The Role of offshore insurance, Jim Bannister Developments Limited 2000
      16
           Source: Tillinghast Towers-Perrin, Swiss Re Economic Research
      17
           The Role of offshore insurance, Jim Bannister Developments Limited 2000




                                                                                             36
4.7     The future evolution of the market and developments in products
4.7.1   Trend from proportional to non-proportional business
        It is difficult to substantiate the generally perceived trend from proportional to non-proportional
        business with quantitative data covering the whole industry. Industry wide statistics do not
        generally provide analysis of treaty business in this way. However, the trend is reasonably well
        documented. The advent of Bermudan capacity, for example, was principally in the area of
        excess of loss reinsurance.

        The following quote comes from Global Reinsurance18 :

        “Coupled with the shrinkage in the population, market leadership also took over, where it
        became more important for cedants to focus on doing business with a small number of large and
        well-capitalised reinsurers, rather than the other way around as it had been pre-1984. Because of
        this, reinsurance underwriters were able to have their way, imposing a risk-excess model on the
        market more broadly, in place of the proportional form that had been prevalent, thereby gaining
        more direct control over their own underwriting and pricing.”

4.7.2   The evolution of ART and securitisation
        In the early 1990’s, potential losses from catastrophe risks exceeded the capacity available in
        the worldwide reinsurance markets. One result of this gap in the global market, especially in
        relation to high level catastrophe cover, was the formation, backed by major financial
        institutions, of the highly capitalised Bermudian catastrophe excess of loss reinsurers, such as
        XL, and Mid Ocean, among others. With rising rates for catastrophe cover and the increasing
        tendency for reinsurers to monitor aggregate exposures, another result was that investment
        banks began to develop alternative solutions to provide ways for reinsurers to offset their
        residual catastrophe exposures, using the large cash reserves of the capital markets as a means
        of raising additional capital in case of major losses.

        Various ART solutions have been developed, including catastrophe options and bonds, and the
        launching in 1995 by the Chicago Board of Trade of an insurance derivative option based on
        indexed case estimates. The latter met with limited success, and some bonds have not reached
        the market (such as the California Earthquake Authority deal of 1996). However, a number of
        significant transactions were successfully completed in the late 1990s, including a ten year
        securitisation by St Paul Re, using a special purpose vehicle in the Cayman Islands to enable it
        to underwrite catastrophe business in the USA and the Caribbean.

        Such deals involve a high amount of investment in time and transaction costs. They also involve
        significant modelling input. A number of investment banks are actively marketing the concept
        of catastrophe bonds to reinsurers, and more of these products are likely to appear in future.

        The involvement of capital markets is increasingly blurring the division between banking and
        reinsurance. Transactions are often complex and this presents an issue for regulators. They need
        to understand the underlying motivation for such transactions, their effects and regulatory
        impact, in order to assess whether their regulatory approach is appropriate.



        18
             Global reinsurance – September 2000 “Look! They’ve killed reinsurance”




                                                                                                  37
4.8   Competitive position of EU reinsurers from a global perspective
      Despite the international nature of the reinsurance market, obstacles to cross-border business
      still exist. In terms of regulatory barriers, there are several areas where regulatory issues could
      have an impact on competition between EU and non-EU reinsurers.

      First, there is a possibility that capital requirements could influence decisions regarding where a
      reinsurer is located. However, in practice the capital required in order to meet the requirements
      of rating agencies and the market generally exceed regulatory requirements to a great extent.
      The EU solvency margin, for example, designed for primary insurance companies, is often
      irrelevant in the case of reinsurance companies, as the requirement imposed by the market is far
      greater. Moreover, the question of location is arguably less important, given the international
      nature of reinsurance.

      Second, the regulatory approach in different territories may exert competitive pressures.
      Compliance costs may be higher where there is a greater regulatory reporting burden, and where
      more regulatory costs are passed on to the reinsurance industry in one territory compared to
      another, there may be competition implications.

      The OECD and the CEA have identified administrative impediments in the EU. These include,
      for example, the obligation for branches of non-EU reinsurers to issue financial statements
      according to local GAAP (generally accepted accounted principles) for the whole group. Certain
      EU countries also make use of systems where assets of the reinsurer must be pledged in order to
      cover outstanding claims provisions.

      According to the OECD and the CEA other obstacles exist. In some countries there is still a
      monopolistic situation in reinsurance through one privileged company, which is usually state-
      owned. In turn, some countries require compulsory cessions in certain lines of business to a
      state company or to identified national reinsurers. Supervisory restrictions, such as requirements
      to register in the host country or limits to cessions, can also exist. Furthermore excise taxes can
      be required19 .

      As an answer to this, the CEA proposes the introduction of a “Single Passport”, which does not
      necessarily mean a harmonisation of the supervision of reinsurers.




      19
           Source: EU Commission, Discussion Paper to the IC reinsurance Subgroup “Approaches to
           Reinsurance Supervision”, 2000




                                                                                                   38
5     Description of the different types of supervision approaches
      currently used in the EU as well as other major Non-EU
      countries
5.1   Scope
      In accordance with the Terms of Reference, this chapter provides “a description of the different
      types of supervision approaches currently used in the EU as well as in major non-EU countries.
      This should include a comparison of the principal characteristics and differences of major or
      leading jurisdictions, with the aim of clarifying the rationale underlying the adopted
      supervisory approach. It should indicate whether the same supervision regimes are used for
      insurance and reinsurance”.

5.2   Approach
      In reporting on the above objective, we undertook the following approach:

      § Use of questionnaires to local KPMG insurance regulatory specialists in each country;

      § Discussions with regulators and use of public information where necessary, to supplement
        information gathered from local offices.

5.3   Introduction: reasons for supervision
      The major common objective of prudential supervision of reinsurance, in those jurisdictions
      where it is supervised, is the need for protection of the interests of the policyholders. Prudential
      supervision aims to minimise the instances of insolvencies of reinsurers.

      Whilst this overall objective is generally valid for the supervision of both insurance and
      reinsurance business, in some jurisdictions reinsurance supervision is organised with a ‘lighter
      touch’ than insurance supervision because reinsurance companies conduct their business
      predominantly in an inter-professional marketplace. A further consideration is the perception in
      other territories that, due to the special characteristics of the reinsurance market, without
      supervision the market in the long term would not work properly (for example in soft markets
      reinsurance companies offer reinsurance cover at uneconomic prices). Thus supervision may be
      in the best interests of economic policy objectives.




                                                                                                 39
      Types of supervision can be classified in a number of ways. The IAIS identifies five main
      approaches20 :

      (i)         no supervision at all;

      (ii)        supervision of reinsurance is restricted to ceded reinsurance of primary insurers only;

      (iii)       the supervisor is authorised to request non-public information about a domestic
                  reinsurer;

      (iv)        every reinsurer doing business with a domestic reinsurer is licensed;

      (v)         uniform licensing being extended with additional requirements for the insurer or the
                  reinsurer.

5.4   Supervising authority
      Supervision of reinsurance can be provided by general public authorities or a special insurance
      department. A further possible form of reinsurance supervision is self-regulation through the
      market, and this is mainly achieved by rating agencies or by cedants’ assessments of reinsurers’
      financial position in deciding whether to place cover. Due to the fact that reinsurance companies
      do business with professionals as described above, self-regulation (principally by the use of
      market mechanisms) might be a viable alternative to other forms of supervision.

      The role of the rating agencies has become more significant in recent years. Rating agencies are
      not only relevant for potential shareholders of the reinsurance companies, but also for other
      stakeholders (such as policyholders). The information provided by the rating agencies can be
      useful in assessing the security of reinsurers, especially their claims paying abilities.

      Rating and regulation are becoming closely connected. They have different agendas, but in
      certain areas they can be complementary to each other. Reinsurance Magazine (August 2000)
      notes that increasing co-operation between the world’s regulatory authorities and the major
      rating agencies is a likely future trend.

      Reinsurance companies are regulated in different ways in terms of which legislation is applied
      to regulating the business. A reinsurance company can be subject to legislation either of the
      country where business is written or of the country of origin.

      A licence in the country of origin is, according to the European Directives, a precondition for
      starting direct insurance activities in a Member State. If the licence is withdrawn, the insurance
      undertaking must stop writing new business. Many EU states also require a licence for
      reinsurance business. The licence has to be obtained in every single country where the company
      wants to write reinsurance business, and where there is a requirement to obtain a licence.
      However, not all countries require a licence from a non-domestic reinsurer.




      20
              Reinsurance and reinsurers: Relevant issues for establishing general supervisory principles, standards
              and practices, February 2000




                                                                                                           40
        Within the EU there is an attempt to provide European reinsurers with a common form of
        certification, taking the form of a statement from the supervisor (Single Passport). In a single
        passport solution the reinsurer, providing it complies with certain criteria and requirements,
        receives an official recognition (passport) to undertake reinsurance business in the EEA, without
        further approval or registration procedures. If at any time a reinsurer fails to meet these
        requirements, the passport can be withdrawn.

5.5     Forms of supervision
        The key features of the supervisory approaches are:

        § licensing requirements;

        § solvency requirements (or an equivalent measure);

        § monitoring (including scrutiny of various aspects of the business, site visits, etc).

5.5.1   Licensing criteria
        Licensing allows supervisors to impose minimum capital and management requirements.
        Additionally, supervisors obtain direct and established access to any information concerning the
        reinsurance business. Licensing criteria vary from country to country. The core requirements
        proposed by the CEA are: acceptable legal form, fit and proper requirements for management,
        prudential solvency requirements, adequacy of technical provisions, approval of controllers
        (shareholders) and at least annual reporting to the regulator.

        As a by-product of the licensing requirement, supervisors can obtain crucial information about
        the reinsurance market in the country.

5.5.2   Financial Supervision
        Financial supervision can include the review of a company’s financial statements and/or
        additional information, the review of technical provisions for their adequacy and solvency
        requirements. Financial supervision can also include investment regulations. The question of
        whether the special character of reinsurance business (for example, reinsurance business being
        more international than insurance business) warrants differences between investment
        regulations for insurance and reinsurance business will need to be addressed.

5.5.2.1 Direct versus indirect supervision
        The current situation in reinsurance supervision demonstrates that there is no commonly
        accepted single method of reinsurance supervision. A European Commission questionnaire on
        the supervision of reinsurance undertakings showed that almost all Member States supervise
        reinsurers either directly or indirectly or they have a mixture of both direct and indirect
        supervision.

        Direct supervision means that any reinsurer conducting business within an EU member state is
        required to be authorised in some way by the supervisor. Direct supervision includes other
        requirements, for example, managers must be fit and proper, adequacy of technical provisions,
        minimum solvency margins, and submission of financial statements.




                                                                                                  41
      Indirect supervision is conducted via the full supervision of direct insurers. A reinsurer is
      examined as a result of the supervisor’s scrutiny of the primary insurer’s outward reinsurance
      programme.

5.6   Supervision of reinsurance in the EU
      Direct insurance activities in the EU are regulated and supervised in accordance with EU
      directives. There are currently no prudential directives dealing with reinsurance. The only
      directive which does deal with reinsurance is 64/225/EEC on the abolition of restrictions on
      freedom of establishment and freedom to provide services in respect of reinsurance and
      retrocession.

      The actual supervision of reinsurers is based on national legislation. This has led to a
      considerable variety in terms of regulation and levels of reinsurance supervision, which
      arguably hinders the further development of the internal reinsurance market.

      Domestic professional reinsurers are not subject to any reinsurance supervision in Belgium,
      Ireland and Greece. Germany, France and the Netherlands apply elements of their direct
      insurance supervisory regime to reinsurers while a reduced licensing regime exists in Austria,
      Italy, Spain and Sweden where only the latter two impose solvency margin requirements.

      Only in the UK, Denmark, Finland and Portugal are reinsurers subject to the comprehensive
      regulation and supervision applied to direct insurers under the single market regime, including
      licensing and thorough on-going financial supervision.

      The following sections highlight areas of differences in the approach towards reinsurance,
      compared to insurance, in various European member states while the table below summarises
      the approaches in the main EU member states.




                                                                                            42
Supervision                                            Germany   France   UK   Netherlands   Italy   Denmark   Sweden   Spain   Luxembourg
Licence is required in order to practice reinsurance
* domestic reinsurers                                     X        X      ü         X          ü        ü        ü        ü          ü
* non-domestic reinsurers                                 X        X      ü         X          ü        ü        X        X          X
Reinsurers are subject to supervision                     ü        ü      ü         ü          ü        ü        ü        ü          ü
Reinsurers are supervised directly                        ü        X      ü         X          ü        ü        ü        ü          ü
Reinsurers are supervised indirectly                      ü        ü      ü         ü          X        ü        X        ü          ü
Reinsurers are a subject to on-site inspections
* domestic                                                ü        ü      ü         ü          ü        ü        ü        ü          ü
* non-domestic                                            X        X      ü         X          ü        X        X        X          X
Management must be “fit and proper”
* domestic                                                X        ü      ü         X          ü        ü        ü        ü          ü
* non-domestic                                            X        X      ü         X          ü        X        X        X          X
Changes in management must be reported
*domestic                                                 X        X      ü         X          ü        ü        ü        ü          ü
* non-domestic                                            X        X      ü         X          ü        X        X        X          X
Sufficiency of technical provisions is examined
* domestic                                                ü        ü      ü         X          ü        ü        ü        ü          ü
*non-domestic                                             X        X      ü         X          ü        X        X        X          X
Solvency margin requirement exists                        X        X      ü         X          X        ü        ü        ü          ü




                                                                                        43
Supervision                                    Germany   France   UK   Netherlands   Italy   Denmark   Sweden   Spain   Luxembourg
Financial statements must be submitted
* domestic                                        ü        ü      ü         ü          ü        ü        ü        ü          ü
* non-domestic                                    X        X      ü         X          ü        X        X        X          X
Annual Submission
* domestic                                        ü        ü      ü         ü          ü        ü        ü        ü          ü
*non-domestic                                     X        X      ü         X          ü        X        X        X          X
Quarterly Submission
* domestic                                       ü (a)     X      ü         X          X        X        X        X          X
* non-domestic                                    X        X      ü         X          X        X        X        X          X
Assets are examined
* domestic                                        X        X      ü         X          ü        ü        ü        ü          ü
* non-domestic                                    X        X      ü         X          ü        X        X        X          X

Sanctions: licence can be withdrawn
* domestic                                        X        X      ü         X          ü        ü        ü        ü          ü
* non-domestic                                    X        X      ü         X          ü        X        X        X          X
Sanctions: fines may be imposed
* domestic                                        ü        ü      ü         X          ü        ü        ü        ü          ü
* non-domestic                                    X        X      ü         X          ü        X        X        X          X


a) only report on development of investments




                                                                                44
5.6.1   Denmark
        Reinsurance business is regulated in Denmark in the same way as direct insurance
        business and based mainly on rules implementing EU directives. This includes
        accounting, investment, solvency, and fit and proper rules.

        The main objectives of the regulation of reinsurance business are, we understand, to
        minimise the possibility of credit loss on reinsurance for the ceding direct insurers. This is
        directly related to the protection of the financial position of the primary insurers and
        therefore to the protection of policyholders.

        Licensing requirements

        A licence is required by incorporated Danish companies to practise reinsurance in
        Denmark. As of 1 April 2000 branches of foreign reinsurance companies (permanent
        establishments) also need a licence. Having a permanent representative will constitute a
        permanent residence. Foreign reinsurance companies, without having a permanent
        residence or a permanent representative in Denmark, can sell reinsurance to Danish direct
        insurers without having a licence in Denmark.

        The rules regarding licensing are the same as for direct insurers. To obtain and maintain a
        licence in Denmark, a reinsurer has to make a standard application to the supervisory
        authority, make the required statutory filings and maintain a level of assets sufficient to
        service the level of liabilities it reinsures. The Board of Directors in Danish insurance
        companies has to determine the sufficiency of the security of the used reinsurers and
        therefore normally only uses reinsurers with good security. The requirements are checked
        regularly by the regulator. The regulator can withdraw the licence if the regulations are
        broken.

        Reinsurers are subject to regular on-site inspection visits by the regulator in the same way
        as direct insurers.

        The board of management and members of the board of directors are required to meet the
        fit and proper criteria, based on EU rules. Changes in management have to be reported to
        the regulator who can withdraw the licence if the management does not meet the fit and
        proper criteria. These criteria are checked at the time of the original submission by the
        company and are normally not checked on an ongoing basis. Normally the regulator will
        not check the criteria if a member of management has already been approved by the
        regulator in another EU or EEU member country.

        Reporting requirements

        The financial reporting requirements are the same as for direct insurers. Audited annual
        financial statements (based on the EU Insurance Accounts Directive) and regulatory
        returns are required. The regulatory returns are in the same form and level of detail as for
        direct insurers.

        Direct insurers as well as reinsurers have to prepare and file audited annual financial
        statements and regulatory returns within 5 months after the year-end. In the near future
        this time limit will be changed to 4 months.




        mk/nb/552                                                                                   45
        Once a year the non-domestic reinsurers (branches) submit a report on their activities to
        the regulator. The report contains information about capacity utilisation and about
        business in general. The branch report has to be certified by a state authorised or
        registered public accountant. A branch of a foreign reinsurer must each year file with the
        regulator a specification of the contracts entered into, analysed by country, and a
        specification of the ten largest ceding companies. General agents have to file two copies
        of the annual accounts for the company with the Danish regulators. A non-domestic
        reinsurance subsidiary must comply with the rules of the domestic reinsurers, i.e. direct
        insurers.

        There are no written rules regarding probable maximum losses and maximum exposures
        but the supervisor is very focused on how direct insurers and reinsurers manage their
        capacity.

        Solvency requirements

        As for direct insurers a solvency requirement calculation has to be prepared. The non-life
        solvency provision is largely derived from amounts in the audited financial statements.
        The life solvency calculations are prepared by and signed off by the appointed actuary. A
        reinsurance company that conducts life reinsurance needs to have an appointed actuary.

        Use of rating agencies

        The Danish Supervisory Authority has implemented a rating model (called REMOS-
        reinsurance monitoring system) to determine the risk profile of the reinsurance cover of
        the insurance companies. The reinsurance programmes of all larger direct insurers are
        registered in REMOS including treaties, cover and security. This system rates companies
        by reference to a number of financial ratios, but also takes into account the level of
        exposure that companies assume when rating the security of a buyer’s entire reinsurance
        programme. However, the information is not available to the public.

5.6.2   Germany
        Reinsurance companies are subject to limited supervision compared to direct insurance
        companies. The rationale for the difference between insurance and reinsurance companies
        with respect to supervision is that insurance companies are business professionals that do
        not need the same level of protection as individuals. Another argument for the different
        treatment mentioned in the literature is that the models for supervision which are
        appropriate for insurance companies do not fit the special character of reinsurance
        business, especially as reinsurance business is more international than insurance business.

        Consideration is being given to revising the existing regulation for professional reinsurers
        in Germany.

        Reporting requirements

        Although reinsurance companies are subject to limited supervision compared to direct
        insurance companies, they have to comply with requirements regarding accounting and
        reporting to the supervisory authority similar to direct insurance supervision.
        Furthermore, reinsurance companies are obliged to submit a quarterly report on the
        development of investments.




        mk/nb/552                                                                                 46
Solvency requirements

The German solvency requirements are based on the European Directives. There is no
statutory solvency margin requirement for reinsurers. However, the supervisor tries to
ensure that reinsurers have a minimum capital at the level required for direct insurers.

Insurer’s procedures for monitoring reinsurer security

The German supervisory authority has published guidance for direct insurers on how to
assess the performance and capacity of reinsurers on the basis of data from financial
statements and other available information. Following this guidance, it is necessary for
direct insurers to review the annual results of the reinsurer in comparison to the previous
year. Other available information has to be taken into account such as information from
brokers or rating agencies. If the assessment by rating agencies is considered, it is
necessary to obtain comparative ratings from different rating agencies. Assessments of
third parties have to be closely checked before being taken into consideration.

The following information, concerning the company’s outwards reinsurance programme,
must be submitted by direct insurers to the supervisory authority:

§ The name of the reinsurance and insurance company or the name of the reinsurance
  broker;

§ The ceded premiums have to be analysed between direct insurance business and the
  assumed reinsurance business. The amount of the ceded premiums has to include the
  premiums paid to the reinsurer as well as portfolio entries;

§ The reinsurer’s share of the gross technical provisions has to be analysed between
  direct insurance business and the assumed insurance business;

§ The liabilities from deposits of reinsurers.

In addition, the supervisory authority obtains the audit report through indirect submission
which must contain information about results from reinsurance contracts (inwards and
outwards) overall and separately for certain lines of business. Also, the auditor has to
comment on the creditworthiness of reinsurance receivables.

On the basis of the submitted information mentioned above the supervisory authority has
the ability to directly assess the reinsurance programme of direct insurers.

The supervisor does not consider the solvency position of a particular reinsurer when
assessing the quality of a company’s reinsurance recoverables since in Germany there are
no solvency requirements for professional reinsurers.

The supervisor takes into account the fact that insurance groups often manage their
reinsurance programme on a group basis in order to manage it more efficiently and to
prevent over exposure to particular reinsurers.




mk/nb/552                                                                                47
        Adequacy of assets

        Reinsurance is not subject to the investment regulations in force for direct insurers.

        For investments valued in accordance with the historical cost principle, the market value
        must be disclosed in the notes.

        There are no restrictions placed on the recognition of assets arising from outwards
        reinsurance contracts.

        Many insurance companies use stress tests in order to quantify their investment risks.
        Reinsurers tend to have more professional knowledge and therefore more sophisticated
        systems. Asset/liability management techniques are still at an early stage of practical use.
        Some insurance companies already use a stochastic model concerning investments.

        Use of rating agencies

        In Germany, the largest insurance companies are usually rated by one of the leading
        rating agencies. Rating is not obligatory. Insurers use ratings for marketing and to
        improve their credit standing. Market trust in ratings is high. More than 700 direct
        insurers and over 40 reinsurers exist, of which 169 are rated by Standard & Poor’s, 12 by
        Moody’s and 17 by Assekurata a German rating agency. The use by the regulator of these
        ratings is very limited and consists merely in suggesting their use to direct insurers when
        assessing the performance capacity of reinsurers.

5.6.3   Ireland
        Traditionally the Irish reinsurance industry has not received the same degree of scrutiny
        as the direct insurance sector. This area is now in the process of being tightened with the
        foundations for further regulation having been laid recently by the Insurance Act 2000.

        The Irish regulator does not operate a formal authorisation process but is able to exert
        control over the establishment of new entrants through an arrangement with the Irish
        companies registry. Under the new Act there will be further requirements in relation to
        authorisation.

        There is currently no formal supervision of reinsurance companies but the reinsurance
        market is relatively young, and a supervisory approach is expected to be introduced
        within the next five years.

5.6.4   Italy
        According to a 1959 Act, Italian undertakings and branches of foreign (EU and non-EU)
        undertakings operating exclusively as professional reinsurers are subject to Isvap´s direct
        supervision.

        Undertakings which intend to pursue only reinsurance business in Italy must be granted
        authorisation by Isvap. In this case, as in the case of transfer of controlling interests in a
        reinsurance undertaking, the same regulations in force in direct insurance apply as regards
        the requirements of good repute and financial soundness of shareholders.




        mk/nb/552                                                                                  48
Isvap tends to substantially extend the more complex regulations applying to direct
insurance; this is why it has introduced a routine procedure under which an ad-hoc
scheme of operations is required in order to verify, apart from the good repute and
professional qualifications of administrators and internal auditors, if an undertaking has
sufficient technical and financial resources to ensure its technical, economic and financial
stability during its first three years of existence. More specifically, Isvap requires
estimates of the balance sheet, and the qualitative and quantitative composition of assets
and liabilities, as well as the profit and loss accounts with the expected amounts of
premiums, loss burden and production and administration costs.

The 1959 Act envisages minimum capital requirements that are nowadays insufficient:
this is why they are calculated on the basis of the needs shown in the scheme of
operations, with special reference to the nature of the risks that the undertaking intends to
cover, the financial balance and the need to represent technical commitments.

No quantitative or qualitative limits are envisaged for assets representing technical
provisions in reinsurance business (done by a professional reinsurer or by an undertaking
which also pursues direct insurance); however, undertakings’ balance sheets must “show
real or easily realisable financial resources for an amount not lower than the existing
technical provisions”.

Professional reinsurers are not subject to present regulations on direct insurance as
regards the solvency margin; nonetheless composites must take reinsurance business into
account when calculating the solvency margin.

Like direct insurers, reinsurers must submit a report on the first half year, annual accounts
and supervisory forms, except for a number of attachments and supervisory forms which
are not technically applicable. In this regard these undertakings – although they are not
obliged to do so – have the report and the balance sheet audited on a voluntary basis.

The balance sheet must be approved before 30 June of the year following the financial
year to which it refers, and can be postponed until 30 September, but in this case the
relevant reasons must be explained in the notes on the accounts.

The chart of accounts that companies must adopt applies to both insurance and
reinsurance undertakings.

The said 1959 Act establishes that reinsurance undertakings must keep, apart from the
books envisaged by the Italian civil code according to the type of company, the register of
contracts, the list of claims reported and the register of premiums, although reinsurance
premiums are exempted from taxes if the latter have already been paid on the direct
premium. According to the same code reinsurance contracts must be proved in writing.

Isvap has the same supervisory and sanctionary powers as those envisaged for insurance
undertakings and – based on the examination of the yearly balance sheet of reinsurance
undertakings or on any other evidence – may require information and documents, express
criticism, raise objections and conduct inspections on the reinsurance premises and on all
aspects of their activity.




mk/nb/552                                                                                 49
        In case of business crisis, Isvap also has the same powers as those envisaged for
        undertakings pursuing direct insurance business even as regards the appointment of the
        ad acta manager, the special management and the company`s compulsory liquidation.

        Finally, on the basis of the valuation of the solvency of a reinsurer not based in a EU
        country, Isvap may not allow any technical provisions of a direct insurer to be covered by
        claims against him.

5.6.5   The Netherlands
        Licensing requirements

        Few reinsurance companies are based in the Netherlands and overseas reinsurers play an
        important role in the Dutch market. Pure reinsurance companies wishing to operate in the
        Netherlands do not require a licence. However, if a company also offers direct insurance
        it is considered to be an insurance company and as a result, all business written by it
        (including the inward reinsurance) falls under the supervision of the Dutch regulator,
        according to EU rules.

        Contrary to the practice with insurance companies, reinsurers do not need regulatory
        approval for their (non-)executive directors. However, when establishing a N.V. the
        company will need ministerial approval. The approval process includes the assessment of
        future directors, although this is generally a formality.

        Reinsurance companies cannot (directly or indirectly) obtain an ownership interest of 5%
        or more in a bank or insurance company without the consent of the regulator. Other than
        this, there are no compulsory guidelines on the investment policy of reinsurers.

        Reporting requirements

        Reinsurance companies are obliged to file two copies of their annual accounts and
        directors’ report with the insurance regulator. The accounts must comply with Dutch
        GAAP. The accounting principles (including the valuation principles relating to technical
        provisions) are consistent with those for insurance companies. Reinsurance companies are
        not required to file returns with the insurance regulator.

        In addition to being required to file their annual financial statements, reinsurance
        companies must provide any information the regulator may need to fulfil its supervisory
        obligations. The regulator has the power to approach the management and supervisory
        board of the reinsurance company when required.

        Solvency requirements

        There are no specific solvency requirements for reinsurance companies. However,
        reinsurance companies founded as a public limited liability company have to adhere to
        general requirements. Reinsurance companies belonging to an insurance conglomerate
        must adhere to the EU directive on solvency requirements for insurance groups that has
        been implemented under Dutch law as of calendar year 2001.




        mk/nb/552                                                                               50
Insurer’s procedures for monitoring reinsurer security

According to a study published by Pension and Insurance Supervision Board (PVK) the
following instruments are used to monitor the reinsurance practice of Dutch insurance
companies:

§ Analysis of annual financial statements of Dutch reinsurance companies. All available
  information is stored in a database and used as reference when reviewing the returns
  of Dutch insurers and assessing the credit risk of the companies’ reinsurance
  recoverables;

§ Review of annual returns;

§ On-site investigations, which include interviews with management and a review of a
  sample of reinsurance contract and transactions. During the interview, the supervisory
  authority discusses the nature and magnitude of the risks ceded, the policy on net
  retention, measures taken concerning catastrophe risks and accumulation of risks, the
  chosen types of reinsurance, the exposure to individual reinsurers, and the selection
  criteria used to identify appropriate reinsurers. During the sample testing, the
  conditions of the reinsurance contracts are reviewed and the internal control
  procedures are tested;

§ Reinsurance is one of the topics addressed during the annual meeting that the PVK has
  with management.

The reinsurance review in the annual returns of a non-life insurance company includes:

§ A description of the reinsurance strategy by line of business (cover obtained, net
  retention, type of reinsurance, measures taken regarding catastrophe risks);

§ A list of all reinsurers with whom the insurer has signed a non-proportional
  reinsurance contract (excess of loss, stop loss);

§ A list of all reinsurers with whom a proportional reinsurance contract has been signed
  that transfers more than 10% of the gross premium (quota share, surplus);

§ For each reinsurer an overview is provided of any outstanding balances, the
  reinsurance premiums ceded, the reinsurer’s share in claims incurred and in the
  technical provisions;

§ Collateral or deposits placed with the company are disclosed if they exceed 10% of the
  reinsurer’s share in the technical provisions.

The reinsurance review in the annual returns of a life insurance company include:

§ A description of the reinsurance strategy by type of reinsurance;

§ Information on the net retention (per incident);

§ A list of all reinsurers including the reinsurer’s share in the technical provisions and
  the amount reinsured by type of reinsurance;




mk/nb/552                                                                                51
§ Collateral or deposits placed with the company are disclosed if they exceed 10% of the
  reinsurer’s share in the technical provisions.

Insurance companies are concentrating the management of their reinsurance programmes
at a group level. Generally speaking, the net retention is maximised for the group as a
whole. Off-shore captives can be established.

In 2000, the PVK drafted new actuarial principles which proposed to link the safety
margins that an individual insurer should apply to the effectiveness of its risk
management policies. Indirectly this would also affect the way that the PVK monitors
outwards reinsurance arrangements. The draft was revised based on comments received
from local insurance companies and other parties involved. The final report was delivered
in September 2001. This report is referred to as the “basic principles for a financial
assessment framework”. On the basis of these principles, the PVK has started to elaborate
practical policy rules for financial testing. However, it will take a few years before the
new policy rules become effective.

Adequacy of assets

Both in shareholders accounts and in the annual returns, investments (financial
instruments and real estate) may be valued at historical cost or market value. Fixed
interest investments may be valued at redemption price.

In May 2001 a specialist group appointed to review the accounting principles applied by
insurance companies issued a report with recommendations to improve the comparability
of the financial statements of insurers. The report will result in new directives that are
intended as an interim standard, awaiting the IASB standard on the accounting for
insurance contracts among others. The recommendations include:

§ valuation of equities at market value and fixed interest securities at amortised costs or
  market value;

§ the immediate inclusion of realised gains and losses on investments in net profit or
  inclusion of realised and unrealised gains and losses on investments in net profit;
  spreading these over time is not allowed;

§ life insurance provision: disclosure of the quantitative result of a statistically
  accentuated adequacy test of the technical provision for life insurance, based on
  modern, realistic principles.

§ non-life insurance provisions: disclosure of the run-off of the claims provision for
  underwriting years already closed. A breakdown of the nature and value of
  developments of the provisions for catastrophes.

Dutch insurance companies disagree strongly with the immediate inclusion of realised
gains and losses in net profit. The outcome of the political debate on the new directives is
as yet unclear.

The annual returns include an overview in which the insurance company must specify its
assets and liabilities that are held in foreign currencies.




mk/nb/552                                                                                52
        The regulator can challenge the valuation of an asset arising from an outwards
        reinsurance contract.

        In the light of IAS 32 that has been implemented in the Netherlands, companies are
        required to provide disclosure in the financial statements on the risks related to their
        financial instruments.

        In life-insurance business, models based on the calculation of the embedded value are
        used for asset-liability management and scenario analysis. The models applied focus on
        asset-liability mismatches.

        Use of rating agencies

        In the Netherlands, insurance companies can apply for a rating by one of the
        internationally acknowledged rating companies, who typically publish the ratings on their
        websites. There is no publicly available rating system designed specifically for the Dutch
        insurance market. The regulator does not disclose any regulatory rating that could be used
        as an indication of the companies’ risks. However, some information in the annual returns
        must be made publicly available. Several parties analyse this information to identify
        developments in the Dutch market and publish “top-10” lists of insurance companies.

5.6.6   Spain
        In general, reinsurance is regulated in the same way as direct insurance, although there
        are minor differences. There is no legal requirement for reinsurance companies to
        maintain a solvency margin.

        Licensing requirements

        Spanish reinsurers and foreign reinsurance entities or business associations which set up
        branches in Spain require authorisation from the “Ministry of Economy”. If a company
        which is registered in an EEA country wishes to establish a branch in Spain a procedure
        similar to that applicable to direct insurers (European passport) is followed.

        Foreign insurance or reinsurance companies or business associations operating in their
        own countries, with or without Spanish branches, may also accept reinsurance operations
        through their registered offices. In the case of entities registered in the EEA, such
        operations may be accepted through branches established in any member state. These
        entities do not require an authorisation.

        Requirements for obtaining an authorisation are the same as those established for direct
        insurance companies and include restriction of statutory activity, submission of a
        programme of activities, forecasts for the first three years, minimum share capital,
        shareholders requirements and effectiveness of management. Ongoing compliance with
        requirements is mandatory for obtaining and maintaining the State authorisation, which
        will be revoked if any non-compliance is detected. Any breaches of the regulation may
        result in the authorisation to underwrite new or to renew reinsurance contracts being
        revoked or suspended, depending on the degree of the breaches.

        Reinsurance companies, like direct insurance companies, are subject to a regular on-site
        inspection visit by the regulator.




        mk/nb/552                                                                              53
All members of the executive management must be individuals of proven integrity and
with appropriate qualifications, as established for direct insurance. These individuals
should figure in the administrative register of senior management. They must satisfy
certain requirements before assuming such positions. The regulator monitors the
requirement generally through inspection of new and existing companies.

Reporting requirements

There are certain differences between the documentation to be presented by insurers and
reinsurers, as follows.

§ In the statistical documentation of balance sheet items, reinsurers should distinguish
  between group, associated and other companies with regard to creditors and debtors
  for accepted reinsurance. Details should also be given to the amount provided for bad
  debts on reinsurance accepted;

§ Model 12 requires a breakdown of technical provisions and deposits (actuarial
  provisions, provisions for outstanding claims and other technical provisions), giving
  details of the amounts for the single line of business;

§ Model 19 requires details of premiums and claims settled by country, analysed
  between EEA member states, Switzerland, the USA and other countries.

The Spanish supervisory board requires annual accounts, director’s report, statistical
information and, where applicable, general and supplementary audit reports. The deadline
for insurance companies is the 10 July of the following year. Reinsurance companies
have to deliver by the 10 October.

The regulator considers probable maximum losses and maximum exposures to the extent
necessary to grant operating licences.

Solvency requirements

Entities carrying out reinsurance operations are required to create, calculate, record and
invest provisions in the same way as direct insurance companies. There are no differences
between reinsurance and direct insurance in regard to the calculation of solvency margins
or the items covered thereby.

Legislation regulating reinsurance tends to favour specialisation, requiring that newly
created entities carry out reinsurance activities exclusively. Additionally, and here there
are no differences with direct insurance, the controlling body favours specialisation by
line of business and risk concentration policies.

We understand that the regulator is principally concerned with the following areas:

§ complexity of the reinsurance business;

§ the risk of insolvency of reinsurance entities which affects both the cedant and its
  insured parties (the protection of the primary insurer’s policyholders);




mk/nb/552                                                                               54
§ the principle of diversifying risk culminates in the reinsurance business and,
  consequently, the concentration of risks on these should be avoided, given the
  increased impact this could have on direct insurance;

§ a perceived need to regulate the continuous innovations in the sector, especially given
  the international scope involved. (It should be borne in mind that almost half of the
  insurance companies operating in Spain are foreign-based).

Insurer’s procedures for monitoring reinsurer security
Spanish legislation only refers to the retention programme as follows: insurance and
reinsurance companies must arrange their reinsurance programmes so that their net
retention is appropriate, given their economic capacity, to maintain the company’s
financial and technical stability.

Information on reinsurance has to be submitted to the regulator. Life insurance companies
(when accepted reinsurance premiums represent more than 10% of total premiums) must
submit details of premiums analysed by individual and group policies, and by periodic
and single premiums, by with and without profit participation, and where the investment
risk is borne by the policyholder. Non-life insurance companies are required to submit a
breakdown of technical income and expenses between direct insurance and assumed
reinsurance (where premiums accepted exceed 10% of total premiums).

The following details must be submitted by insurers to the insurance authorities about
ceded business: type of reinsurance contracts, retention/priority and limit of the contracts
(for each class of business representing more than 20% of direct business); listing of
reinsurers representing more than 5% of the ceded business and details of year end
balances with these reinsurers.

In addition, insurance companies must keep, inter alia, a register of accepted and
outwards reinsurance contracts with identification data for each individual reinsurance
contract. The information has to be distinguished between treaties and facultative
contracts. The information for each contract should include characteristics of the risks
reinsured, conditions of reinsurance coverage and all other matters with an economic
impact.

The documentation to be submitted annually to the regulator requires a breakdown of
reinsurance by country.

No specific programmes have been set up by the Spanish regulator to monitor insurance
companies’ risk management procedures, either generally or in particular in relation to
the reinsurance programme.

Adequacy of assets
Historical cost accounting rules are applied in accounting. However, for solvency
purposes, hidden reserves arising from the difference between the cost and market value
of investments are taken into account.




mk/nb/552                                                                                 55
        The currency in which the investments are realisable must be matched with the currency
        in which the insurance liability will be settled, when the assets in other currencies exceed
        7% of the total and when they exceed 20% of liabilities in the currency. There is an
        exception when the liabilities are payable in non EEA currencies. As a rule, financial
        investments must be issued in or subject to the control mechanisms of the OECD or the
        EEA, and deposited in the EEA. Similarly, real estate investments must be located within
        the EEA. Exceptions must be approved by the regulator.

        The use of asset-liability management techniques for the management of expected
        payments for life insurance has increased. This enables insurance companies to guarantee
        technical interest rates on the basis of allocated investments, provided that they comply
        with certain requirements regarding maturities, financial duration and sensitivity of the
        current value to variations in interest rates at specified future dates.

        Use of rating agencies
        In Spain, only a few insurance entities have been rated by an external agency (generally
        Standard & Poor’s, Moody’s and Fitch IBCA) as there is no significant market pressure
        to obtain a rating. The regulations assume the use of credit rating in the following cases:
        use of appropriate assets for the coverage of life insurance provisions ; in the case of use
        of derivatives traded in OTC markets, both parties must have received a favourable credit
        rating; accounting legislation also takes into consideration the credit rating of the issuer
        when valuing fixed income securities.

5.6.7   Sweden
        Reinsurance is in most aspects regulated in the same way as direct insurance. Some
        differences however exist, but not concerning solvency requirements.

        Licensing requirements

        A licence is required in order to practise reinsurance. However, this only concerns
        Swedish companies. Non-Swedish reinsurers can practise their business in Sweden on a
        cross-border or establishment basis without a licence. Branches from other countries than
        EEA or Switzerland have to apply for a licence. The same rules apply for direct insurance
        and reinsurance.

        It is necessary to file an operating/business plan before obtaining a licence. Licensed
        entities are checked on a regular basis. If the requirements are not met the licence may be
        withdrawn.

        Reinsurers (companies and foreign branches) can be subject to on-site visits by the
        regulator in the same way as for direct insurers.

        The same fit and proper requirements for controllers, directors and managers apply for
        reinsurers as for direct insurers, including a need to report changes in the management.
        An approval is not required when there are changes in management.




        mk/nb/552                                                                                56
        Reporting requirements

        Reporting requirements are almost the same as those established for direct insurance
        companies and the same deadlines are imposed depending on the size of the business.

        Branches from EEA companies have to prepare a balance sheet and profit and loss
        accounts. The requirements are the same as for direct insurance. Subsidiaries have to
        present an annual report.

        Regarding probable maximum losses and maximum exposures, the supervisor usually
        does not monitor this area.

        Solvency requirements

        Reinsurance companies have to file an annual solvency declaration to the supervisory
        authority, and also report the level of technical provisions.

        The solvency calculations are based on the EU directives. No major changes have been
        made.

        Use of rating agencies

        Most of the largest Swedish companies are rated by Standard and Poor’s based on public
        information. At present there is no mechanism that gives an insurance company a
        regulatory rating or grading. However, the regulators are currently working on an
        international grading system to ensure stability within financial institutes including
        insurance companies.

5.6.8   France

5.6.8.1 Future revised regulations
        A new law was adopted by parliament in May 2001 imposing specific regulation on
        reinsurers which is more extensive compared to existing regulation. This new law will
        soon be complemented by detailed regulatory rules. The new rules would subject
        reinsurers to an authorisation procedure similar to that for direct insurance companies. It
        would include adequate financial and technical means for the business to be written,
        quality of shareholders, procedures for financial recovery, and comparable sanctions
        (including withdrawal of the authorisation). Solvency requirements (including technical
        provisions, their coverage by admitted assets, and the solvency margin) will be
        implemented in the future, and will differ from those applied to direct insurance
        companies to take account of the special features of reinsurance business.

5.6.8.2 Regulations currently in place
        Licensing requirements

        There is no need for a license for assumed reinsurance. There are no specific rules for
        reinsurance companies, but French reinsurers have to file some of the direct insurer
        information with the French supervisor, the “Commission de Contrôle des Assurances”,
        who also has the right to control French reinsurers.




        mk/nb/552                                                                               57
French reinsurers can be subject to on-site inspections like direct insurance companies.
The same fit and proper requirements apply to reinsurers as to direct insurers.

Reporting requirements

French reinsurers have to file with the supervisor in a format derived from the direct
insurer’s format. Financial statements must be approved by the shareholders no later than
6 months after the year-end.

Reinsurance subsidiaries are treated as a special category of domestic reinsurers. There
are no supervisory requirements for branches of foreign reinsurers. Only reinsurers
incorporated in France are supervised and considered supervisable.

Newly established reinsurers must send specified details to the supervisor including the
statutes of the company and names of the directors. Financial statements required by the
supervisor are the same as for direct insurers.

Solvency requirements

French reinsurers are not required to cover their technical provisions by admitted assets or
to comply with a solvency margin.

Insurer’s procedures for monitoring reinsurer security

As stated in the framework of the mission of permanent supervision of insurance
companies, it is the French supervisor’s responsibility to assess the adequacy of
reinsurance programmes of direct insurers on a case by case basis.

In meeting this responsibility, the supervisor may examine in detail the reinsurance
programme during on-site audits to insurance companies.

Regarding information required to be submitted to the supervisor, property and casualty
insurance companies need to file two schedules every year that give summarized
information on assumptions and cessions:

§ Schedule C3 which provides a breakdown of assumed and ceded reinsurance
  premiums, insurance liabilities, technical balance (premiums less loss expenses less
  acquisition expenses), and interest expense on cash deposits from reinsurers. This
  information is further analysed for group companies and non group companies, and
  for French and foreign reinsurers;

§ Schedule C13 which analyses operations by accident year for ceded paid losses,
  reinsurers’ share of loss reserves at the beginning and at the end of the financial year,
  and for some categories, increase in reinsurers’ share of earned premiums.

The technical provisions are assessed before reinsurance.

A company’s reinsurance recoverables are admitted in coverage of these gross technical
provisions only up to the amounts secured by collateral from the corresponding reinsurers
(or cash deposits or letters of credit from banks under specific conditions). Insurance
companies also have to check the financial heath of their reinsurers, as recommended by
the OECD.




mk/nb/552                                                                                 58
        The French insurance law provides prudential rules on the quality of collaterals.

        The supervisor has two prospective tools in order to monitor risk management procedures
        in relation to the reinsurance programmes. He can examine the annual solvency report,
        which analyses the sufficiency of assets as regard liabilities and possible future solvency
        margin requirements; and the quarterly schedule called T3, which aims at assessing the
        effect of stress-testing on asset-liability management. Moreover, the supervisor can ask
        the company to provide any information deemed necessary and carry out on-site
        inspections.

        So far the supervisor has controlled individual companies. The implementation of the
        1998 insurance groups directive will change this by introducing a group approach.

        Adequacy of assets

        Assets are usually carried at cost except fixed income securities which are carried at
        amortised cost. Investments are to be individually written down if a decrease in market
        value is considered permanent. If the market value of the overall investment portfolio
        other than bonds is lower than the carrying value, then the value is written down to the
        market value.

        Insurance liabilities have to be covered by assets in a currency which matches the
        currency of the insurance liability. Pending the entering into force of the new regulation,
        this requirement does not apply to reinsurers.

        Regarding assets arising from outwards reinsurance contracts, cash deposits by reinsurers
        enable the insurance company, in principle, to have adequate assets in coverage of gross
        technical provisions. Reinsurance recoverables are admitted in coverage of gross
        technical provisions up to the amounts secured by collateral.

        The supervisor has recently developed some schedules (quarterly report) to assess
        exposure to interest rates and capital market changes on the assets and liabilities of the
        companies.

        Use of rating agencies

        In France, only the major insurance groups have a rating provided by a rating agency
        (Standard & Poor’s, Moody’s or Fitch IBCA). They are automatically rated when listed
        on a US stock exchange, otherwise French insurance companies have to request rating
        agencies for a rating. No use of ratings is made by the supervisor.

5.6.9   United Kingdom

5.6.9.1 The company market
        In the UK, the legislative framework for supervision makes little distinction between
        insurance business and reinsurance. The main objective of the regulation of reinsurance
        business is the same as that for direct business, i.e. confirmation of the company’s
        ongoing ability to meet its obligations to policyholders (in this case other insurers).




        mk/nb/552                                                                               59
Licensing requirements

Reinsurance business is regulated in exactly the same way as direct insurance business,
for which the requirements are derived from the appropriate EU Directives. In order to
become authorised, an applicant is required to submit financial forecasts and other
information required by the relevant legislation.

Reinsurers are subject to on-site inspections in the same way as direct insurers. Fit and
proper requirements apply exactly as for direct business, as does the need for the
regulator’s approval of changes in management.

Reporting requirements

The reporting required by the regulator is the same as for that for direct business. A return
is to be submitted normally annually, but in certain cases (e.g. new companies) quarterly.
This is a standard form and includes calculation of the required solvency margin, balance
sheet, revenue account, reinsurance arrangements and detailed analysis of revenue
headings. All annual returns require a report by the auditor and in the case of life business
an actuarial report on the adequacy of technical provisions is required also.

The UK branches of non EU-companies are supervised in the same way as UK
companies. In addition returns with their global figures have to be submitted.

Solvency requirements

Reinsurers in the company market are subject to the same solvency requirements as direct
insurers. However, there are differences in the approach taken by the regulator,
recognising the different nature of reinsurance business.

In addition to the standard regulatory reporting and solvency tests to which all UK
authorised insurance companies are subjected, the regulator carries out certain additional
checks on insurance companies operating in the London Market. These involve
principally looking at the reinsurer’s solvency position under a number of different loss
scenarios and estimating probable maximum losses, in order to assess the degree of risk
inherent in the liability side of the balance sheet. Also, an attempt is made to rank
reinsurers according to risk assessments made by the regulator based on its loss scenario
testing.

This type of approach represents an attempt to recognise the additional risks posed by a
reinsurer, as a result of the complexity of its business and the volatility inherent in its
reinsurance liabilities. With regard to the solvency position, there are two principal risks
posed by claims provisions: first, the possibility that future claims events in respect of
contracts already entered into may exceed expected levels, and second, that claims
already incurred but not settled may exceed amounts provided within liabilities.
Interestingly, neither of these possibilities are explicitly dealt with by the current solvency
margin methodology.




mk/nb/552                                                                                   60
        For professional reinsurers writing life business, the solvency margin calculation applies
        a different rate (0.1% rather than 0.3%) to capital at risk. Other differences apply to
        reinsurance business rather than to reinsurance companies. The matching and localisation
        requirements do not apply to reinsurance business. Non-life reinsurance business is
        analysed separately in the regulatory returns and is accounted for on an underwriting year
        basis rather than an accident year basis. Most fundamentally, the authorisation of non-UK
        reinsurers applies to their worldwide operations, not just to business carried on in the UK.

5.6.9.2 The Lloyd’s market
        The supervisory approach within the Lloyd’s market is somewhat different to the
        company market in the UK. In particular, Lloyd’s operates a risk based system and
        focuses its regulatory efforts on perceived high risk areas. Whilst the approach
        encompasses both insurance and reinsurance business, the emphasis on risk means that
        reinsurance business may be monitored more closely; syndicates are required, for
        example, to produce Realistic Disaster Scenarios, identifying their potential exposure to
        major losses.

        In addition, Lloyd’s has on occasion undertaken reviews into the market-wide use of
        specific reinsurers, in attempts to identify potential problems.

        Further details of the regulatory approach adopted by Lloyd’s is included in Appendix 3.

5.7     Supervision of reinsurance in major non-EU countries
        The varied approach to supervision of reinsurance across the EU is reflected elsewhere in
        the world. However, where reinsurance is regulated, the approach usually differs little
        from the approach to regulation of insurance business. Solvency or equivalent
        requirements are usually based on the same rationale, and although there may be higher
        requirements for reinsurers writing significant amounts of catastrophe business, the
        overall approach to supervision is usually similar.

5.7.1   Canada
        Reinsurance is explicitly defined and included within the overall business of insurance.
        The main objective of the regulation of reinsurance business is to minimize the possibility
        of credit loss on reinsurance for the ceding direct insurers.

        Licensing requirements

        Whilst reinsurance can be bought from unlicensed reinsurers, the ceding company, in
        order to obtain reinsurance credit for its own statutory reporting purposes, would typically
        require the reinsurer to post a letter of credit.

        To obtain and maintain a licence in Canada, a reinsurer would make a standard
        application to the federal regulator, make the required statutory filings and maintain a
        level of assets in Canada sufficient to service the level of liabilities it reinsures, as
        prescribed in the regulator’s rules.




        mk/nb/552                                                                                 61
The Canadian regulator operates a licensing system, and supervises reinsurance business
in essentially the same way as direct insurance business, except that reinsurers do not deal
with the public and accordingly do not have market conduct regulation to comply with.

There are a number of subjective matters to be considered by regulators in deciding
whether to grant a licence including, adequate financial resources to provide minimum
capital; providing a sound written business plan for the review of the regulator; a record
of successful business operations by the owners of at least five years; management team
with proven experience; compatibility of the proposal with the best interests of the
Canadian financial system; equally favourable treatment accorded to Canadian companies
in the countries in which the foreign insurer principally conducts business; ability to
comply with all relevant Canadian legal requirements.

Minimum initial capital requirements are higher for reinsurers than for direct writers,
reflecting the perceived greater inherent risks in reinsurance. Ongoing capital
requirements are also calculated based on the actual risks undertaken by the insurer, on
the same basis for both direct insurers and reinsurers.

Initial and ongoing governance requirements are the same for reinsurers as for other
insurers, appropriate books and records must be maintained in accordance with GAAP;
generally accepted actuarial standards must be used; appropriate systems of internal
control must be maintained; directors and officers, as well as the auditor and appointed
actuary, have duties to remedy breaches of law and regulation, and to report to the
regulator any breach that is not remedied on a timely basis, as well as any condition
threatening the “well being” of the insurer.

Once an insurer (whether a direct insurer or a reinsurer) is initially licensed, it is subject
to ongoing supervision. This monitoring is done by the regulator through review of
annual audited financial returns and actuarial opinions, unaudited quarterly financial
returns, and an annual contact or visit from regulatory staff.

The regulator can place restrictions on a licence (e.g. limiting or prohibiting new
business, limiting renewals) unless conditions such as inadequate capitalisation are
remedied. Withdrawal of a licence would prevent an insurer from carrying on business.
These sanctions, together with monetary fines, can be used to compel insurers to remedy
a wide range of problems, such as poor market conduct, poor governance procedures or
other breaches of the legislation or regulation. In extreme cases, the regulator can take
control of an insurer and place it in liquidation, ordinarily to protect policyholders and
claimants when an insurer is insolvent.

Reinsurance companies can be subject to regular on-site inspection visits by the regulator
as for direct insurance companies.

Directors and certain officers, including the chief executive officer, secretary, treasurer,
controller, actuary and any other officer reporting to the board of the CEO, are required to
meet the fit and proper criteria. Changes in senior management are ordinarily reported to
the regulator as a courtesy. There are no requirements for management and no regulatory
approval is required.




mk/nb/552                                                                                  62
Reporting requirements

The financial reporting requirements are essentially the same as for direct insurers,
audited financial statements and regulatory returns are required, together with an
appointed actuary’s report on the technical provisions for policy liabilities. The regulatory
returns are in the same form and level of details as for direct insurers.

All reinsurers are required to report on a GAAP basis, regardless of whether they are
foreign-owned or domestic, and regardless of whether they are organised as a company or
a branch.

Reinsurers have adapted to shorter reporting deadlines by the use of estimates and more
actuarial analysis. This has been made necessary both by earlier deadlines for regulatory
reporting, and also by accelerating reporting deadlines of their parent companies, some of
which are publicly listed.

Solvency requirements

Technical provisions are based on accepted actuarial standards. Equalisation provisions
are forbidden as they are contrary to both GAAP and actuarial standards. An appointed
actuary’s report is required on the technical provisions for policy liabilities. The non-life
solvency provision is largely derived from amounts in the audited financial statements,
while the life solvency provision is subject to annual audit by the external auditors.

Reinsurers are subject to risk-based minimum solvency requirements – a minimum asset
test (MAT) for non-life, and minimum continuing capital and surplus requirement
(MCCSR) for life. These requirements are the same as those that apply to insurers.

Insurer’s procedure for monitoring reinsurers security

The regulator reviews the general details of the reinsurance programme. An outline of the
reinsurance programme of a non-life insurer is typically included in the annual appointed
actuary’s report. In addition, the regulator has specified more detailed requirements for
earthquake exposures, including studies estimating the insurer’s probable maximum loss
in a given geographic area. These are used to monitor the preparedness of an insurer,
including its reinsurance arrangements, to survive such a loss.

The annual statutory return schedules referred to above requires a list of reinsurers
(identifying which are affiliates) and the premiums and claims ceded to each company.
Separate schedules provide details of reinsurance ceded to unregistered reinsurers, so that
the impact on the solvency margin can be calculated. Schedules in the statutory return
require details of any collateral or deposits placed by the reinsurer.

The regulator places emphasis on the assets maintained in Canada, and the solvency
ratios of the Canadian operation of the reinsurer.

Regarding the monitoring of risk management procedures in relation to the reinsurance
programme, the regulator is beginning to see the results of life insurer companies’ risk
self-assessments, and the review of those self-assessments in the course of annual
inspection visits. All insurers are expected to monitor the credit worthiness of their
reinsurers.




mk/nb/552                                                                                 63
        Larger multinational insurers have increasingly coordinated reinsurance within their
        groups, with the result that the coordination often occurs outside the country, and
        frequently involves affiliated company reinsurers. The regulator must usually deal with
        the information available within Canada.

        The regulator is not currently reviewing the treatment of reinsurance ceded for regulatory
        purposes.

        Adequacy of assets

        In non-life business, a cost basis is used in both the shareholder accounts and regulatory
        returns. Investments are set at market value for solvency testing purposes.

        In life business, cost basis is used in both the shareholder accounts and regulatory returns,
        except for investments in equities and real estate, which are marked to market at 15% and
        10% per year respectively. Similarly, realised gains on equities and real estate are
        deferred and amortised to income at 15% and 10% per year respectively.

        There are no specific foreign exchange regulatory requirements. However, mismatched
        currency risks could give rise to higher actuarial liabilities and higher risk-based capital
        requirements.

        Explicit asset-liability matching techniques are used in life business. Future cash flows
        are modelled to develop life insurance actuarial liabilities, and specifically to develop a
        provision for asset-liability mismatches. Portfolio management practices are reasonably
        sophisticated for life insurers. Non-life insurers commonly manage liquidity in more
        basic ways, and are most likely to deal with diversification in terms of concentration
        limits or similar approaches.

        Use of rating agencies

        In Canada, the publicly quoted stock companies for the most part have a rating provided
        by a rating agency. Most smaller companies do not engage a rating agency. Where the
        insurer does not request a rating, one rating agency (AM Best) may publish a
        “provisional” rating based on published financial information. Standard & Poor’s, AM
        Best and Canadian Bond Rating Service are the main rating agencies. Ratings generally
        include both capital instruments and claims paying ability. There is no explicit use by the
        regulator.

5.7.2   The USA
        The regulation of reinsurance in the USA closely follows that of direct insurance
        business. Licensing follows the same structure and solvency requirements follow a risk
        based capital approach as required for insurers.

        Reinsurance is generally covered by the broad definition of insurance in most states, but
        all states have specific reinsurance statutes under their insurance law.




        mk/nb/552                                                                                 64
Licensing requirements

Foreign companies can establish themselves as either an Authorised (licensed) or
Accredited reinsurer. Each state has unique licensing requirements. The requirements to
become an Accredited Reinsurer is mandated by the NAIC’s “Model Law on Credit for
Reinsurance”. Certain provisions of the Accredited Reinsurer provision are unique to
reinsurers.

To be accredited there are accounting/financial reporting and requests for information and
on site inspection criteria. Sanctions which may be imposed are withdrawing the licence
or accreditation or possibly requiring more stringent reporting.

Generally, key management and financial reporting personnel and members of the board
of directors are required to meet the criteria of “integrity and competence of
management”.

Reporting requirements

For reporting purposes, reinsurance is generally subject to less detailed reporting in
regulatory filings. Statutory filing requirements are guided by the filing company’s state
of domicile. For authorised reinsurers, annual statements are due to the NAIC. Non-
domestic companies have the same filing requirements as domestic companies.

For regulatory filings, non-life insurance companies include the following based on
relevance:

§ A description of the reinsurance strategy (cover obtained, net retention, type of
  reinsurance, measures taken regarding catastrophic risks);

§ A list of reinsurers with whom the insurer has amounts due;

§ Collateral or deposits placed with the company are disclosed if they exceed 10% of the
  reinsurer’s share in the technical provisions.

Solvency requirements

Solvency requirements follow a risk based capital approach, as for direct insurers. This
approach, based on a model established by the NAIC, measures the various risks in the
business, including investment risks, and calculates a score relative to the insurer’s stated
capital. In the event of deficiencies, certain actions are taken. The models are relatively
complex and cover a broad range of risks. Since the underlying accounting model has
changed with effect from 1 January 2001, these models will need to be revisited to ensure
proper calculations. In addition, an older more traditional model still exists but generally
has little impact.

Supervision is subject to the rules and regulations of individual states. Most states have
adopted the NAIC’s capital models, but in some cases the local rules are more or less
restrictive, by requiring a minimum or larger capital requirement.




mk/nb/552                                                                                 65
Insurer’s procedure for monitoring reinsurers security

One interesting feature of the US approach is the extensive information required by
regulators in respect of a cedant’s outwards reinsurance programme:

§ The review of outwards reinsurance is based on periodic state regulatory examinations
  of cedants. Furthermore, significant contracts are likely to be discussed and agreed
  with regulators in advance. There are a number of credit related requirements to help
  minimise potential losses on outwards reinsurance. For example, the reinsurer may
  have to post letters of credit or trust accounts in order for receivables to be allowed to
  be counted for regulatory capital requirements.

§ Cedants are required to continually monitor the credit worthiness of their reinsurers.
  Statutory requirements stipulate such monitoring, as well as accounting and auditing
  literature.

§ In connection with the quarterly and annual reporting of financial results, insurers are
  required to provide comprehensive information, showing the reinsurers and their
  related balances. This information is fairly well scrutinized to monitor trouble
  situations. In addition, limited additional information is contained in notes to the
  financial statements filed by the company in February following the year-end.

Adequacy of assets

Invested assets are valued at amortised cost for fixed maturity investments and market
value for equities.

Financial statements typically contain a number of disclosures relating to risk
management and financial instruments used to manage risks. In addition, the SEC
imposes a significant amount of disclosures on market risks relating to derivatives and
financial instruments in the annual form 10-K.

Regulators impose significant financial and modelling requirements on companies, such
as cash flow testing. The financial statements include many disclosures, but the filings
with regulators contain much more detail.

Use of rating agencies

Several rating agencies exist in the US. AM Best is the most widely recognised rating
agency for the insurance industry. While the rating agency information is important,
insurance regulators generally do not rely significantly on this information, but prepare
their own analysis and information to monitor companies. There are several types of
ratings including, claims paying ability or capital instruments. The regulator does not use
any internal ratings or market mechanisms in its regulatory process.




mk/nb/552                                                                                66
5.7.3   Bermuda
        The approach to the regulation of reinsurance broadly follows direct insurance, and there
        is no difference in methodology in calculating solvency margins for insurance and
        reinsurance companies.

        Licensing requirements

        A licence is required in order to practise reinsurance in Bermuda. To obtain it a reinsurer
        would make an application to the regulator and be required to maintain the required
        amount of capital to support its licence application. The applicant must submit a business
        plan including information on its products, investments, capital, reinsurance, management
        and shareholders. The company must appoint a principal representative, a statutory
        auditor and a loss reserve specialist, all of which have statutory duties under the
        regulation.

        The Bermuda regulator does not generally conduct site visits to reinsurance or insurance
        companies, although he has the power to perform them. All new applications of reinsurers
        are reviewed for fit and proper persons. Additional requirements for this criteria and
        routine on site inspections are scheduled to be introduced in the current year.

        Reporting requirements

        All reinsurers are required to have an annual audit and must file an annual statutory
        return, which includes an audit opinion, a solvency certificate, and analysis of premiums,
        key operating ratios and an opinion from a loss reserve specialist (actuary).

        Solvency requirements

        Although the formula and principles are the same, different parameters are used in
        calculating the solvency margin, depending on the classification of the business. The
        classification could be one of four types:

        § Class 1 – Single parent captive insurer

        § Class 2 – Multi-owner captives

        § Class 3 – Insurers and reinsurers not included in Class 1,2 or 4 and normally including
          reinsurers writing third party business, insurers writing direct policies with third party
          insurers and finite risk insurers.

        § Class 4 – Insurers and reinsurers having the intention of underwriting direct excess
          liability and/or property catastrophe reinsurance risk.

        As seen above, insurers and reinsurers are generally class 3. However, if there is excess
        liability or property catastrophe reinsurance risk i.e. the higher risk categories, then they
        are classified as Class 4.




        mk/nb/552                                                                                 67
        Based on the above Classes, the solvency calculation is as follows:

        Class of insurer              Class 1           Class 2           Class 3          Class 4
        Minimum Capital &             $120,000          $250,000          $1,000,000       $100,000,000
        Surplus
        Premium Test
        First $6 million of NPW       20%               20%               20%              50% (Note 1)
        (net premium written)         10%               10%               15%              50% (Note 1)
        NPW excess of $6 million
        Loss and Loss Expense         10%               10%               15%              15%
        reserve

        Note 1: For Class 4 insurers, the test is 50% of net written premium with maximum
        deduction for reinsurance of 25% of GPW (Gross Premium Written).

        The main objective of the regulation of the reinsurance business is to ensure that the
        reinsurer has sufficient solvency and liquidity to meet claim obligations.

5.7.4   Switzerland
        Reinsurance business is covered in insurance regulation but most requirements for direct
        insurance companies do not apply to reinsurance companies.

        The Swiss reinsurance market is of course unique, being home to some of the world’s
        largest reinsurers. The concept of self-regulation by market forces is evident in the
        regulatory approach.

        Licensing requirements

        The supervisory legislation provides that all insurance companies constituted under civil
        law and carrying on business in Switzerland are subject to supervision unless exempted
        by it. Exemption from supervision applies to foreign insurance companies operating in
        Switzerland which write reinsurance business only.

        Therefore foreign insurance companies which intend to carry on reinsurance business in
        Switzerland require no authorisation and are exempted from federal supervision.
        Authorisation and supervision is required for Swiss reinsurers.

        In order to obtain a licence a company must submit a business plan. The business plan
        must contain information concerning business purpose and internal organisation; the
        planned business areas and geographic areas of activity; information necessary to assess
        solvency; the by-laws; the balance sheet and annual financial statements or, if applicable,
        the opening balance sheet and the budget; the tariffs requiring approval and other
        insurance materials to be used in Switzerland; details as to the technical reserves,
        reinsurance and, if applicable, amounts payable on settlement as well as participation in
        surpluses. Breaches of the regulations may lead to the withdrawal of the licence.




        mk/nb/552                                                                                68
Reporting requirements

Reinsurers must complete an annual reporting package to the regulator. Disclosures per
line of business are required for direct insurance and reinsurance. Reinsurers often used to
report their underwriting results one year in arrears, but this practice is now uncommon.

Solvency requirements

Whilst there is no solvency requirement set out in legislation, the Swiss regulator does
apply a benchmark of 20% of net premium as a minimum equity requirement. There are
no fit and proper requirements and no consideration of probable maximum losses and
maximum exposures by the regulator.

Insurer’s procedures for monitoring reinsurer security

Swiss reinsurance companies report the names of all relevant reinsurance partners to the
regulator in the annual reporting package. In general Swiss companies reinsure their
business with highly-rated global reinsurers. Therefore no special focus for the regulator
has been needed in this area in the past.

The reinsurance programme is not an explicit part of the business plan during the
licensing/authorisation process. It is common practice that the risk assessment is a key
theme in the informal meetings between the regulator and management in the start-up
phase.

No additional information on the reinsurance protection programme is collected by the
regulator in the annual reporting package. At an interval of about four years, a team from
the regulator visits the insurance company and discusses such subjects with management
directly.

There is no requirement to provide the regulator with details of collateral or deposits.

Most Swiss insurance companies are part of a global group controlled by a foreign
company or are global players themselves. As a tendency, more and more business is
aggregated within the group and reinsurance coverage is placed with third-party
reinsurers with a considerable retention limit. The treatment is supported by the fact that
most direct insurance companies hold a license for assumed reinsurance as well.

The regulator is not currently reviewing the treatment of reinsurance ceded.

Adequacy of assets

Individual company financial statements and regulatory returns generally use lower of
cost and market value for equities without writing up investments previously written
down when the market value recovers. Fixed interest securities are normally valued at
amortised cost. Market value is often used in consolidated financial statements. The
difference between market value and cost may be taken into account in assessing
solvency.




mk/nb/552                                                                                  69
There are requirements to hold “designated assets” to match the insurance liabilities and
at most 30% of these assets may be foreign. However, there are no requirements as to
where the securities must be deposited for a Swiss company. The “designated assets”
must be held separately from the other assets of the company whether they are held by the
company itself at its head office or by third parties. For obligations denominated in a
foreign currency, the insurance institution has to invest at least 80% of the designated
assets in valuables of the same currency. Foreign insurance institutions must have at their
disposal in Switzerland assets in the amount of the solvency margin, computed on the
basis of the Swiss business.

There are no restrictions on recognition of assets from outwards reinsurance except for
those inherent in the EU calculation of the solvency margin.

Companies are beginning to calculate measures such as value at risk on their asset
portfolio, but linkages between asset and liability risk is a theme being looked at by
companies rather than something that is already in place.

Use of rating agencies

The major players in the Swiss market are rated by the major international agencies
(Standard & Poor’s analyses 36 Swiss insurance and reinsurance companies and AM Best
analyses 37 companies). The regulator does not make any systematic use of ratings in the
regulatory process, in practice little disclosure is given. There is no mechanism in
Switzerland which feeds back to the market any regulatory grading either implicitly or
explicitly.




mk/nb/552                                                                               70
6       The rationale with regard to supervisory parameters

6.1     Scope
                                                                          the
        In accordance with the Terms of Reference, this chapter examines “ rationale with
        regard to supervisory parameters such as:

        - the examination of the adequacy and spread of reinsurance arrangements at the level
          of the primary insurer, the admissibility of reinsurance assets for the primary insurer,
          etc.;

        - licensing or registration;

        - fit and proper criteria, notification of managers and shareholders at specified levels,
          adequacy of technical provisions, assets, solvency margin, the importance of
          maximum exposure techniques for risk monitoring by the reinsurer, the possible use of
          rating agencies;

        - on site inspections.

        The study should examine the broad impact and relevance of different accounting
        practices, reporting and disclosure requirements (including nature and frequency). The
        study should comment on the relative importance and feasibility of supervising the
        parameters in question and its practical implementation with regard to EU and non-EU
        registered reinsurers”.

6.2     Approach
        In reporting on the above objective, we undertook the following approach:

        §   Use of existing specialist knowledge;
        §   Use of questionnaires to KPMG offices and a number of interviews with reinsurers;
        §   Reviews of existing published sources.

6.3     Extent of supervision
6.3.1   No supervision or self regulation
        In a fully liberalised system with free reinsurance trade between domestic insurance
        companies and domestic/foreign reinsurers, insurers are free to choose their reinsurers
        and are responsible for their business.

        A minimal control supplemented by self-regulation, in practice, means that reinsurers
        capable of self-regulation are allowed considerable freedom in carrying out their
        business, with a minimum of interference from the authorities. In self-regulation, the rules
        are drafted by market participants with an intimate knowledge of the market who are best
        placed to maximize the effectiveness of regulation while minimizing the business costs




        mk/nb/552                                                                                71
        Free reinsurance trade between insurers and reinsurers offers the advantage of high
        flexibility for the spreading of risk among reinsurers and makes it easier for participants
        to respond to market needs. Advocates of such a system argue that supervision can create
        an inequality in the market which may influence effective competition.

        The absence of any supervision may lead to the use of low-quality reinsurers, affecting
        the solvency of insurance companies and may affect transparency of the market and
        overall stability. The majority of EU members support supervision since they do not want
        insurers to obtain poor quality reinsurance. In addition the reinsurance market is
        becoming more risky with for example the rising number of captive reinsurance
        undertakings or the growing concentration of risks, so greater protection seems to be
        required for reinsurers. As the global economy continues to grow, the need for stable and
        secure reinsurance will grow with it.

        Some in the reinsurance industry state that there is no justification for detailed state
        supervision in a wholesale business such as reinsurance. Commercial insurers and
        reinsurers deal with other professional corporations, business to business. These
        corporations do not need special protection. The insurance companies are well equipped
        to distinguish honest and well-capitalised business partners from dubious and financially
        weak reinsurers.

        They argue that the objective of reinsurance regulation is unclear. The objective of
        insurance policyholder protection would not be achieved by regulating reinsurance. The
        cases of insolvency of reinsurance companies are rare and no insurance company has
        become insolvent as a result of the insolvency of a reinsurer. Most reinsurance
        insolvencies have occurred in regulated markets. Reinsurance is an economic asset. It
        enables a wider spread of risk, which enables direct insurers to write more business. Any
        disruptive regulation that hampers the supply of reinsurance capacity would have a
        negative impact on insurance policyholders, as insurance companies will provide less
        capacity as a consequence. Any heavy-handed reinsurance regulation would be
        ineffective and disruptive. The reinsurance market has become very innovative in recent
        years, so that a special difficulty of regulation will be keeping regulators educated on the
        new types of products.

        In summary, it can be said that opponents of the self regulated reinsurance market are
        driven by the fear of insolvencies of reinsurance companies, because of the complexity of
        the business. Unregulated markets have shown in the past that the inherent risk does not
        seem to be higher than in regulated markets. There is also no evidence that cedants all
        over the world consider risk in these markets higher. Our analysis did not show that self
        regulated companies have an inferior market position or have to accept lower premiums.

6.3.2   Limited or comprehensive supervision
        A comprehensive direct supervision system generally involves financial supervision and
        on-going control.

        Limited supervision involves the application of only some elements of the direct
        insurance supervisory system to reinsurers.




        mk/nb/552                                                                                 72
In a rapidly changing reinsurance world and reinsurance market dynamics, it may become
increasingly difficult for a primary insurer to assess the reinsurer’s security. If the
reinsurers are directly supervised, the supervisor will be concerned about reinsurance in
comparison with other innovative financial arrangements and will monitor the financial
position of the reinsurer 21 . On the other hand, it may be difficult, if not impossible, for
supervisors to take full responsibility for assessing the reinsurers’ security. However, the
supervisor faces the same difficulties of a rapidly changing market and is not even a
market participant.

It is argued that reinsurance is becoming more prevalent while at the same time the scope
of the risks covered is continuously growing and hence the potential for losses is rapidly
increasing, and the number of captive reinsurance undertakings is rising. Such evolution
means that more prudence is required and that indirect supervision may be insufficient.
Others argue that direct supervision is too strict and should be reserved for new market
players, for which evaluation is not yet established.

In a direct supervision system, the reinsurer has to submit financial information to the
supervisory authorities. The supervisor may have more information and more capacity
than a ceding insurer (in indirect supervision) to assess a reinsurer’s security.
Requirements set by the regulator on capital adequacy or admissibility of investments
may be stricter and take into account fuller information than that provided to a ceding
insurer, so that the regulator can make a broader and deeper assessment.

Many countries consider it an advantage that reinsurance supervision is done in the same
form and detail as for direct insurers. Generally, at least some of the elements of
insurance supervision are used for reinsurance companies. Another advantage is that it is
relatively easy to implement a system based on the rules already applied to direct
insurance.

However, some state that the current regulatory regime for direct insurers cannot simply
be applied in its entirety to the reinsurance sector. There are key differences between the
regulation of retail and wholesale markets.

Reinsurance is a business conducted between sophisticated parties of essentially equal
bargaining power. Companies buying reinsurance policies do not need the same kind of
protection as private policyholders. Models for supervision which are appropriate for
insurance companies do not fit the special character of reinsurance business, especially as
reinsurance business is more international than insurance business.

Some aspects require special consideration such as the correct level of technical reserves
for a reinsurer and its calculation and accounting or the necessity of different solvency
margins and separation of funds for entities carrying on both direct and reinsurance
business.

Such an approach requires extra resources to enforce the rules which means the
supervisory costs are higher than under a system of indirect supervision.




21
     Reinsurance and reinsurers: Relevant issues for establishing general supervisory principles,
     standard and practices, February 2000




mk/nb/552                                                                                           73
        The IAIS notes that an insurance supervisor may encounter problems in exercising the
        supervision of both the insurer and the reinsurer in that it may have a conflict of interest
        concerning the confidentiality of information received.

        In the United Kingdom, some associations, like the International Underwriting
        Association of London (IUA), argue that the information currently required is not as
        appropriate to the supervision of reinsurers as it is to the supervision of primary insurers.
        Less information could be demanded in terms of quantity than is required of the primary
        sector insurers. More appropriate key data could be provided by reinsurers earlier in the
        process than at the present time. The regulator could also aim to promote high standards
        and best practice by establishing benchmarks and issuing guidance notes on issues such
        as off-balance sheet items or reinsurance credit risk.

        To conclude, advocates of regulation are motivated solely by the need to prevent
        insolvencies. If direct supervision is chosen as a general system, it can fulfil its objective
        only if the regulating authority has knowledge and capacity to follow the rapidly
        changing variety of products and can cover the whole (global) business of a professional
        reinsurer. The experience of the past has shown that insolvencies of reinsurance
        companies occurred infrequently and have been more common in regulated markets.
        Reliance on regulation can stop direct insurers from taking full responsibility for
        choosing the right partner for retrocession.

6.4     Overview of supervisory parameters
6.4.1   Direct and indirect supervision
        There are two levels at which supervision can be applied to reinsurance business: direct
        supervision and indirect supervision. Indirect supervision, which focuses on the
        reinsurance arrangements of the direct insurer, is aimed at protecting policyholders
        against the risk of a direct insurer defaulting as a result of a failure in its reinsurance
        protection. The primary purpose of direct supervision of reinsurance companies is to
        maintain confidence in a country’s reinsurance market. The fact that those jurisdictions
        which do regulate reinsurers do not prohibit direct insurers from placing cover with
        unregulated reinsurers indicates that they do not consider direct supervision of
        reinsurance to be a pre-requisite for the protection of policyholders, although clearly any
        rules which serve to promote the secure operation of reinsurers should in turn enhance the
        security of direct insurers and thereby indirectly improve the protection of individual
        policyholders.

        Direct and indirect supervision therefore have distinct purposes. It follows that it is
        possible for a jurisdiction to have either or both direct and indirect supervision. Direct and
        indirect supervision are not alternatives to each other.

        Indirect supervision was recommended by the OECD in 1998 in its “Recommendation of
        the Council on assessment of reinsurance companies”.




        mk/nb/552                                                                                   74
6.4.2   Classification of parameters 22

6.4.2.1 Parameters relating to direct supervision
        The principal parameters relating to direct supervision, grouped by the IAIS insurance
        core principles, are as follows:

        § licensing:

             - fit and proper criteria for management;

             - review of business plan;

        § passport systems:

        § changes in control;

        § corporate governance;

        § internal controls and risk management;

        § prudential rules on assets:

             - diversification requirements;

             - restrictions on asset types;

             - asset valuation rules;

             - matching rules;

        § prudential rules on liabilities:

             - liability valuation rules and restrictions on discounting;

             - rules on methods to be used;

             - certification by loss reserving specialist;

        § capital adequacy and solvency:

             - solvency margins;

             - resilience and scenario testing;

             - equalisation and catastrophe provisions;




        22
             This section mainly follows the IAIS Core Principles and the supervisory parameters
             associated with each principle. (cf. IAIS Insurance Core Principles, October 2000) The
             classification of the IAIS Core Principles has slightly been modified in some cases, e.g.
             derivatives have been considered together with assets.




        mk/nb/552                                                                                        75
        § market conduct;

        § financial reporting;

        § on-site inspection:

             - inspection by the supervisor;

             - inspection by third parties, such as auditors.

6.4.2.2 Parameters relating to indirect supervision
        Principle 10 of the IAIS Core Principles relates to reinsurance which requires insurance
        supervisors to be “able to review reinsurance arrangements, to assess the degree of
        reliance placed on these arrangements and to determine the appropriateness of such
        reliance”23 . In other words, this principle relates to indirect supervision. The principal
        parameters relating to indirect supervision are:

        § direct review of reinsurance programme;

        § limits on maximum exposures;

        § admissibility of reinsurance assets for the primary insurer;

        § collateral requirements;

        § diversification requirements;

        § use of rating agencies;

        § restrictions on use of non-regulated reinsurers;

        § restrictions on use of “unapproved reinsurers”.

6.5     Parameters relating to direct supervision
6.5.1   Licensing

6.5.1.1 General features of a licensing system
        According to the IAIS Licensing Handbook the term “licence” is understood as the
        authority for a company to carry on insurance business, based on contracts between
        policyholders and the company, provided the company is subject to supervision by the
        competent authorities. In the Directives “authorisation” is used with the corresponding
        meaning.

        It is clear that such a definition must be suitably adapted to reinsurance. Certain
        amendments would have to be made in order to reflect the fact that there is no direct link
        between the reinsurer and the policyholder.



        23
             ibid paragraph 21




        mk/nb/552                                                                               76
By requiring the licensing of reinsurers, according to the IAIS, supervisors would obtain:

§ an overview of the companies engaged in reinsurance in a country (e.g. to control
  activities in money laundering);

§ assurance that minimum capital and management requirements are met;

§ direct access to any information regarding the reinsurance business.

A licensing system would have to be adapted for reinsurance companies wanting to do
reinsurance business. Existing entities would need to fulfil licensing requirements in
order to continue carrying on reinsurance business. Traditionally in direct insurance the
granting of a licence means that the supervisor has performed a thorough examination of
the insurance undertaking. If the licensing is not granted or is revoked the company can
no longer carry on reinsurance business.

Licensing in general plays an important role in ensuring efficiency and stability in the
market. Strict conditions governing the formal approval of insurance companies are
necessary to protect insurance users. The licensing process may also help ensure that fair
competition exists among companies in the market.

Requirements are preconditions for granting a licence and must be met at all times during
the on-going business operations. It is necessary to consider the licensing requirements
applied to insurance companies to see if they can be adapted to reinsurance companies.
They are as follows (according to Supervisory Standard on Licensing from the IAIS):

§ legal form and head office of the company;

§ objective of the company;

§ minimum capital;

§ fit and proper criteria for directors and/or senior management;

§ control of shareholders;

§ affiliation contracts and outsourcing;

§ product control (general policy conditions, technical bases for the calculation of
  premium rates and provisions);

§ articles of incorporation;

§ actuaries and auditors.

The withdrawal of the licence creates a clear legal situation and improves transparency of
the market. The supervisor needs to have at its disposal the right to withdraw the licence.
As a legal consequence of this withdrawal, the reinsurance company is no longer
permitted to carry on reinsurance business. It gives a clear mandate to the supervisor to
remove unsuitable companies from the market.




mk/nb/552                                                                                77
        In this system, cedants are better able to judge their reinsurers, as they are submitted to a
        minimum level of requirements. But on the other hand, there is the “moral hazard” that
        the cedant may place too much reliance on the fact that the reinsurer is licensed and
        controlled by the supervisor. Supervision of reinsurers by the regulator should not exempt
        the direct insurer from establishing its own controls over reinsurer’s security.

        It is also argued that licensing is not a standard in itself, but rather a sanction mechanism
        to enforce the standards. If direct insurers were obliged to do business only with
        reinsurers that fulfil certain standards, the objectives could also be achieved through
        indirect supervision.

        Furthermore, introducing a licensing system in a previously non or less regulated sector
        could be difficult to implement. It might be difficult to require existing companies which
        do not meet the regulatory requirements to cease activities. A system of licensing brings
        additional costs of implementation and administration, such as the cost of the
        authorisation procedure.

        In European countries where a licence is needed for reinsurance companies, generally the
        rules used are the same as for direct insurers. In some countries, in the case of life
        business there are minor differences between the solvency requirements for direct and
        reinsurance business.

        The advantage of a licensing system is that it is the maximum protection for the insurance
        industry that regulation can provide. On the other hand, it represents the maximum
        intervention in the market. The question is, whether the aims of a licensing system can be
        achieved via a passport system without affecting the market mechanism. The market will
        probably punish companies without a passport, so that the effect strived for is reached in
        either case.

        A licensing system within the EU may affect competition in the global reinsurance
        market and relations with Non-EU countries and off-shore locations have to be
        considered. If the licensing system is implemented this disadvantage will have to be
        compensated by additional benefits.

6.5.1.2 Fit and proper criteria for management and controllers
        The main objective of such criteria is to assess whether reinsurance entities are soundly
        and prudently managed and directed and that their key functionaries (directors, managers,
        shareholders and other who exercise a material or controlling influence over the affairs of
        the reinsurance entity) do not pose a risk to the interests of present and future cedants of
        these entities24 .

        The criteria could cover the following persons, as proposed by the Australian Regulation
        Authority:

        - directors, in the case of a locally incorporated reinsurer;

        - senior management;

        - the approved auditor;




        mk/nb/552                                                                                 78
- the approved valuation actuary, where relevant;

- the agent, in the case of a branch; and

- other key staff, who are responsible for important decisions.

The supervisor must monitor compliance with the standards on an ongoing basis. A
person is fit and proper if that person has:

- never been convicted of an offence under national or foreign law in respect of conduct
  relating to a financial institution or conduct relating to dishonesty;

- never been bankrupt, applied to take the benefit of the law for the relief of bankrupt or
  insolvency debtors or compounded with the person’s creditors;

- formal qualifications, including membership of professional associations and bodies
  and the nature of binding professional codes of conduct and enforcement of these
  within the professional body;

- no potential conflicts of interest;

- a business track record and appropriate experience;

- demonstrated competence in the conduct of business duties;

- demonstrated integrity in the conduct of business activities;

- a good reputation within the business and financial community.

Each reinsurer should provide the regulator with details of those persons acting in the key
positions and notify immediately if a person to whom this standard applies no longer
complies with the tests of fitness and propriety.

The demonstration of business competencies for management is a complex requirement,
especially for reinsurance. The business is heterogeneous so it is necessary that, as a
minimum, any head of a department has specialist knowledge of the segment. The
international nature of the reinsurance business makes it even more complex. For
example, the underwriting of life business differs totally from that of a typhoon risk in
Japan.

Some of the EU members use these criteria in the supervision of reinsurers. Generally fit
and proper requirements apply exactly as for direct business, including the need to report
changes in the management. The same criteria for insurance companies seem to be
appropriate for reinsurers.




24
     IAIS Fit and Proper Principles




mk/nb/552                                                                                79
        Fraud prevention could be supported by developing fit and proper testing instruments.
        When reinsurers are subjected to direct supervision the same fit and proper requirements
        would apply. In the case of a non-licensed reinsurer, fit and proper testing would need
        special attention. It would be helpful to have more structured information available about
        the fitness and propriety of the management of reinsurers25 .

        From the IAIS point of view, fit and proper testing is important. The reinsurer’s activity is
        essential in the comprehensive chain of risk spread and reduction sought by the insurer.
        Therefore, fit and proper testing should be applicable to all management activities in the
        risk spreading process beyond the primary insurance sector, including the reinsurance
        sector.

        There is a wide agreement in the insurance industry that members of the board of
        directors in an insurance company, direct insurer or professional reinsurer, should have an
        appropriate qualification based on theoretical and practical knowledge and experience
        and be personally liable. This is based on recognition that failures of insurance companies
        can arise from bad management, criminal activities and lack of resistance to shareholders’
        pressures.

        The first EU Council Directives provide that the home member state shall require every
        insurance company for which authorisation is sought to “be effectively run by persons of
        good repute with the appropriate professional qualifications or experience”. These
        Directives only relate to direct insurers. However, there is a general acceptance that
        professional reinsurers should also be expected to meet such requirements.

        Regarding the persons who have to meet these requirements, these might be any director,
        controller manager or main agent of the reinsurer, as provided by the UK Insurance
        Companies Act, or as proposed by the CEA restricted to the members of the board of
        management, since they manage the company and have the prime responsibility and
        power to do so.

        Professional reinsurers cover the whole insurance market which is heterogeneous. It will
        always be necessary to have sufficient underwriting expertise in every area covered.

6.5.1.3 Review of business plan
        Before granting authorisation, insurance supervisors invariably obtain a business plan, in
        a specified format, from the entity applying for a licence to undertake insurance business.
        (This requirement in enshrined in the EU insurance directives and is applied by those
        jurisdictions which regulate reinsurance companies.) In the EU, the requirement to submit
        a business plan applies only prior to authorisation. Once authorisation is obtained there is
        no general requirement for an insurer to submit subsequent business plans although
        supervisors might require plans if there are special circumstances.




        25
             Reinsurance and reinsurers: Relevant issues for establishing general supervisory principles,
             standards and practices, February 2000




       mk/nb/552                                                                                            80
        This information may help the regulator to:

        § form an initial assessment of the adequacy of the capital and reinsurance arrangements
          of the proposed operations;

        § monitor actual business volumes and profitability against what was envisaged at the
          point of authorisation;

        § identify particular risk areas, such as outsourcing arrangements.

        Moreover, in discussing the plans with the applicant, the regulator can form a view of the
        extent to which management is aware of the company’s regulatory obligations.

        If subsequently business volumes are higher than those in the plan, the regulator can
        intervene to require the company to inject further capital.

        It would be relatively easy to introduce such a requirement for reinsurance companies
        across the EU. The costs of complying with such a requirement would not be material.
        The value to the regulator of such a requirement is however to be questioned, because it
        could not assist in assessing the reinsurer’s security.

6.5.2   Passport System
        Instead of a licensing system, the CEA proposed in May 2000 a passport system. In this
        system, undertakings may choose to adhere to the system or to remain outside it.

        It aims to establish an EU model for reinsurance supervision and to promote more
        efficient cross-border trade in the reinsurance sector through increased security and
        through the elimination of statutory trust fund requirements.

        A passport system would replace supplementary supervision for reinsurance companies in
        the host country, or let their cedants enjoy certain benefits linked to the passported status
        of the reinsurer.

        The CEA proposed a passport applied to professional reinsurers. The IAIS has produced a
        recommendation which stated that the passport could be applied to professional
        reinsurers, underwriting associations and direct insurers accepting reinsurance.

        The existing entity must fulfil certain requirements to receive a single passport or in order
        to receive some advantages linked to the system. If the passport is not given or is revoked
        the entity can continue to do reinsurance business, but will not enjoy advantages linked to
        the system.

        The passport could take the form of a standard document which would confirm that the
        company meets the requirements. The respective supervisors would have to be able to
        check these requirements, to pass on the results of the checks to the home market and
        other markets, and to withdraw the document if the requirements were no longer met.




        mk/nb/552                                                                                  81
The standards set must be adequate. Each country of origin would have to impose similar
minimum core requirements before granting approval to companies seeking to do
business in other participating countries. Major aspects that could be included in a
possible EU framework for reinsurance supervision, which are proposed by the CEA or
the IAIS; are as follows:

§ legal form requirement;

§ corporate governance issues: “fit and proper” requirement;

§ shareholder control;

§ operating/business plan, for authorisation; (IAIS only)

§ financial and supervisory reporting (on at least an annual basis);

§ technical provisions appropriate and adequate;

§ prudent solvency requirements;

§ investment rules; (IAIS only)

§ powers of intervention for supervisors;

§ supervisory intervention in cases of reinsurers in difficulty – withdrawal.

Under a mutual recognition scheme, the regulator in each participating country recognises
companies approved by the regulators from the other participating countries, which could
enable reinsurers to trade freely in the geographical area of mutual recognition.

As argued by the IUA, the objective for a European passport could be to attain mutual
recognition with the equivalent North-American system. Such a system would leave
companies the choice of whether they would like to adhere to the system or not. But the
position of the supervisor would be weaker as compared with a licensing system, as
supervisors would not have the option of removing unsuitable companies from the
reinsurance market. If a company did not fulfil the essential solvency requirements, the
supervisor could revoke the passport but not stop the business. In practice, there would be
probably no insurance company that would cede business to such a reinsurer.

If licensing systems are in place in certain countries, it would be seen illogical to replace
them with a passport system, and some in the industry argue that such system could entail
extensive additional requirements which would create additional costs. The system could
also result in an obligation for foreign reinsurers to make security deposits for reinsurance
companies which would not have the passport.

Many US reinsurance associations argue that a mutual recognition system between EU
countries and the US is premature. For them the proposal would represent a decrease in
the level of such security within the US, although it could represent an improvement with
respect to the security of reinsurance recoverables as compared to the level where they
currently exist in certain EU countries. As US reinsurers are not afforded a single
passport within the US it would place them at a competitive disadvantage as compared to
non-US reinsurers.




mk/nb/552                                                                                 82
        The US reinsurance industry disagrees that current practices such as trust fund
        requirements or tax restrictions constitute major obstacles in reinsurance and asserts that
        both requirements do nothing more than contribute to a level playing field among US
        reinsurers and non US reinsurers. Regarding excise tax, the US has entered into treaties
        with a number of countries (such as France, Italy, UK, Germany) waiving the collection
        of insurance excise tax. According to the US reinsurance industry, trust fund
        requirements are not imposed on a “compulsory basis”. If a non-US reinsurer wants to do
        business in the US, without subjecting itself to the full scope of US regulatory laws
        imposed upon US reinsurers (creation of a licensed affiliate or licensing a branch), the
        non-US reinsurer must secure its obligation so that US regulators need not be concerned
        with its financial status or the level of regulation of its place of domicile, but remain
        confident that it will meet its US obligations while it is solvent or in the event that it
        becomes insolvent. This strong position is criticised in the European Union.

        Some of the German interviewees mentioned that the US deposit requirements are only
        relevant for new reinsurers intending to enter into the market; the established reinsurers
        have already met the US requirements by establishing a US subsidiary which is subject to
        supervision in the US.

        The major argument against a passport system is that regulation cannot displace
        companies from the market after the withdrawal of the passport. The reinsurance market
        is globally considered as a working market mechanism, so that a passport probably will
        be established as a standard, like ratings in the past. The withdrawal of a passport will
        therefore, even more than not applying for a passport, cause market reactions resulting in
        the possibility of reduced business volume.

        The idea of the single passport system is already included in the proposal for a Directive
        of the European Parliament and the Council on the activities of institutions of
        occupational retirement provisions (COM(2000)507final) of 11 October 2000. National
        regulations on licensing and supervision remain unaffected by this directive.

6.5.3   Changes in control
        In insurance business, as defined by the IAIS, the insurance supervisor should require the
        purchaser or the licensed insurance company to provide notification of the change in
        control and/or seek approval of the proposed change; the supervisor should establish
        criteria to assess the appropriateness of the change, which could include the assessment of
        the suitability of the new owners as well as any new directors and senior managers, and
        the soundness of any new business plan.

        For many countries, where a licensing system exists, the rules applied for reinsurers are
        the same as for direct insurers. In some countries an approval is required when there are
        changes in management in reinsurance companies.

        As pointed out by the CEA, there is an agreement within the industry that a reinsurer’s
        group structure should be transparent, which means that major shareholders of the
        reinsurer should be disclosed. Shareholders who have controlling interests should be able
        and sufficiently qualified to promote a sound and prudent management of the reinsurer.
        The qualification of the shareholders is to be presumed if the managerial team meet the
        requirements of diligence as well as competence and personal qualification.




        mk/nb/552                                                                               83
6.5.4   Corporate governance
        EU insurers and reinsurers already have to operate within the corporate governance
        regimes that apply to the generality of companies and these vary from country to country.
        For example, some countries (for example Germany and the Netherlands) require two tier
        boards, one executive, one non-executive. In the UK, it is considered best practice for
        boards to consist of both executive and non-executive directors, although there is no
        binding requirement for companies to adopt such a structure.

        In general, EU insurance regulators do not impose explicit corporate governance
        requirements although it is implicit in the fit and proper requirements that the board will
        contain individuals capable of carrying out all the necessary roles.

        The fit and proper requirements could be bolstered by requiring companies to document
        the responsibilities of individual directors and senior managers and to provide the
        regulator with these details. The rationale for such a requirement is that it makes the
        individuals concerned pay greater regard to their regulatory responsibilities.

        In addition, if not already a requirement of general corporate law, insurance supervisors
        could require boards to adopt explicit policies on the following26 :

        § the corporate governance principles of the undertaking;

        § the company’s strategic objectives;

        § the means of attaining those objectives and evaluating progress towards those
          objectives;

        § board structure and appointment procedures;

        § division of responsibilities;

        § risk management functions;

        § external audit and internal control procedures.

        Given the existing variety of corporate governance regimes, it would be difficult to
        introduce a set of comprehensive harmonised rules on corporate governance for
        reinsurance companies. However, a requirement for reinsurers to document senior
        management responsibilities could be introduced without involving significant effort by
        companies.

6.5.5   Internal controls and risk management
        The need for reinsurance companies to operate adequate systems of internal control is
        self-evident. There are a number of approaches that supervisors can take to monitoring
        the adequacy of internal controls systems:




        26
             These areas are based on the IAIS’s Core Principles Methodology approved in October 2000.




        mk/nb/552                                                                                    84
§ requiring directors to produce a certificate that internal controls are adequate;

§ issuing guidance notes on the adequacy of controls and requiring directors to report
  any areas of non-compliance with the guidance notes;

§ requiring external auditors routinely to report on the adequacy of internal controls;

§ using external accountants to carry out specific internal control reviews;

§ carrying out audits of internal controls themselves.

The objective of all these parameters is to ensure that companies have adequate controls
in place and that the controls are properly operated.

A requirement for directors to produce a certificate on control adequacy could readily be
applied to reinsurers and, given that reinsurers should already have adequate controls in
place, should not introduce any additional regulatory burden. However, such certificates
give only limited comfort to supervisors.

Reinsurance is a complex business with exposure to a wide range of operational and
financial risks. The reinsurance market is international with a great deal of cross-border
activity. Risks assumed are more complex due to the diversity of reinsurance contracts.
There is rapid product innovation with the growth of more novel form of risk transfer.
Reinsurance assumes large exposures to catastrophes. Reinsurance being a global
business, exposures may arise in many jurisdictions increasing the degree of legal risk to
the reinsurer.

In these conditions, it is essential for reinsurance to have appropriate administrative
systems and adequate internal control.

The risk management and internal control systems have to be adequate and appropriate
for monitoring and limiting risk. This includes, in particular, the development,
implementation and maintenance of adequate and appropriate policies and procedures for
monitoring and managing:

  ü     Underwriting risk

  ü     Retrocessions

  ü     Credit risk

  ü     Investment risk

  ü     Globalised risk portfolio

  ü     Currency risk

  ü     Timing risk




mk/nb/552                                                                                 85
        New approaches to risk management include stress testing and dynamic financial
        analysis. These new approaches take an integrated view of market and reinsurance risks.
        Alternative risk transfer is also being increasingly used as a risk management tool and
        should be taken into account by regulators in understanding the implications and
        formulating appropriate regulations.

        Annual dynamic analysis reports (used in the US) model the impact on future financial
        condition of various adverse developments with regard to both assets and liabilities. The
        model takes account of factors such as investment losses or market value decreases, falls
        in the level of investment income, and a variety of other factors affecting profitability of
        the business such as claims, lapse rates and expense levels.

        The internal model that many insurance and reinsurance companies are developing to
        manage risk exposure, to allocate their capital efficiently and to provide management
        with tools for business decisions, could be used by supervisors to analyse relevant
        information (Further developments are given in chapter 8).

        If supervision is considered necessary, supervisors need to review the adequacy and
        appropriateness of reinsurers’ risk management policies and procedures. Risk
        measurement methods, risk management processes and strategic asset allocation should
        be disclosed to the supervising authority.

        Generally there is a trend towards improvement of risk management systems. This affects
        the reinsurance industry as well. We did not recognise any differences between markets
        where the supervisory authority monitors risk management and others.

6.5.6   Prudential rules on assets

6.5.6.1 Diversification requirements
        Diversification requirements can operate at two levels. One is to require companies to
        avoid a concentration in any one type of investment. Thus a company can be prohibited
        from investing more than a certain percentage of its investments admissible for solvency
        purposes in property or equities. The other is to prevent companies from investing more
        than a specified percentage of their investments in any one entity.

        Reinsurance companies in jurisdictions which regulate reinsurers are already subject to
        such requirements. In general the investment strategies of reinsurance companies are not
        fundamentally different from those of direct insurers and it seems unlikely that
        reinsurance companies would have to change their investment approach to comply with
        the introduction of admissibility limits.

        On the other hand, it is unclear whether it is necessary to have specific rules enshrined in
        legislation to ensure that reinsurance companies appropriately diversify their investments.
        A general requirement for companies to avoid undue concentrations, backed up by
        reporting requirements which enabled supervisors to identify high concentrations, would
        be simpler and could be equally effective.




        mk/nb/552                                                                                 86
6.5.6.2 Restrictions on asset types
        The basic objective of restricting companies from investing in certain asset types is to
        prevent insurance undertakings from investing in illiquid or volatile assets. However, in
        the case of derivative instruments, there is the additional objective of preventing
        companies from taking on additional risks which may not be evident to the regulators.

        As with admissibility limits, the rules could be extended to reinsurance companies but, as
        with diversification requirements, it is unclear whether detailed rules are strictly
        necessary. The reinsurance industry argues that reinsurers should have the freedom to
        manage their investments in accordance with their business and investment plans.
        Provided that investments are properly valued and disclosed, it is unclear that it is
        necessary to have such restrictions. Such rules can have the adverse consequence of
        preventing reinsurers from entering into innovative investment arrangements which may
        give a better return than conventional investments or provide a better matching of
        liabilities.

        Regarding new risk transfer products, the supervisor should take into account their
        growing use. Disclosure of these products should be enhanced to achieve sufficient
        transparency. The accounting and valuation should properly reflect all possible
        commitments and rights. Solvency requirements should take the characteristics of these
        products fully into account.

6.5.6.3 Asset valuation rules
        Reinsurance companies are, of course, already subject to the general accounting
        requirements, whether regulated or not. Basic valuation principles vary between EU
        countries, some stipulating the market value principle, others the historic cost principle.
        Where investments are shown at the lower of historic cost and market value in the
        financial statements, the market value has to be disclosed in the notes.

        Supervisors can supplement the basic accounting rules by:

        § specifying more detailed valuation rules for particular asset classes;

        § eliminating optional treatments that are available under general accounting rules.

        There are a number of reasons for imposing additional requirements:

        § more specific rules and fewer options mean that the balance sheets of reinsurance
          companies are more readily comparable with each other. This assists both supervisors
          and direct insurance companies in assessing the relative financial strength of different
          reinsurance companies.

        § it ensures that the assets are valued in a way consistent with the rationale behind any
          solvency margin requirements.

        § it reduces the risk that companies will place an inappropriately high valuation on
          assets where it is not easy to establish a market value.




        mk/nb/552                                                                                87
        There is a strong case for subjecting reinsurance companies to more specific asset
        valuation rules regardless of whether reinsurers are subject to regulation. Indeed, if
        reinsurers are not regulated it is more important that direct insurers and their supervisors
        are able to assess accurately the financial strength of reinsurers.

        Where there are harmonised solvency margin requirements, it is illogical to permit
        different asset valuation rules. For example, if the appropriate minimum solvency margin
        for a company which values its assets at historical cost is 20% of premium income, it will
        clearly be necessary for a company which values its assets at market value to be subject
        to a higher percentage of premium income.

        Valuation rules are already applied to all direct EU insurers and regulated reinsurers and,
        since reinsurers’ investment strategies are not different in principle from those of direct
        insurers, there is no reason why they should not be extended to reinsurance companies.
        Moreover, such a requirement could be introduced even if reinsurers were not subject to
        full regulation.

6.5.6.4 Matching rules
        Supervisors can require insurers to reduce their mismatch risk by requiring them to match
        assets and liabilities. Examples of such requirements are:

        § requiring companies to match foreign currency liabilities with assets in that currency
          and to ensure the holding of sufficient assets of appropriate nature, term and liquidity
          to enable the company to meet insurance liabilities as they become due;

        § requiring life companies to match linked liabilities with the same assets as are used to
          determine the unit price.

        Currency matching is a much more difficult issue for reinsurers since in many cases they
        will not be certain precisely in which currency a liability might arise and, in addition, will
        typically face liabilities in many more different currencies than a direct insurer.

        In recent years, insurers and reinsurers have developed increasingly sophisticated
        techniques for matching assets and liabilities to reduce the overall level of risk. The
        introduction of rigid matching rules could adversely affect the development of these
        techniques.

        An alternative approach might be to require reinsurers to disclose in their published
        financial statements the techniques they use to match their investments to their liabilities.
        Such an approach would be simple to implement and should not be onerous.

6.5.7   Prudential rules on liabilities
        The rationale for prudential rules on liabilities is two-fold. In the first instance, the
        regulator wishes to ensure that insurers use appropriate techniques to determine
        accurately what their true liabilities are; and secondly to ensure that insurers retain
        sufficient funds to meet these liabilities.




        mk/nb/552                                                                                  88
6.5.7.1 Liability valuation rules and restrictions on discounting
        In principle, it is possible for regulators to specify rules on:

        § the discount rate (if any) to be applied to liabilities to allow for the investment return
          on technical provisions;

        § the extent to which future expenses need to be taken into account;

        § the extent to which future premiums (or premium margins) can be taken into account;

        § the basis for recognising premium income (i.e. the basis for calculating unearned
          premiums and unexpired risks);

        § the extent to which acquisition costs should be deferred.

        For life business the amount of uncertainty related to underwriting risk is relatively small
        and the existence of rules on such matters as the discount rate to be used, the extent to
        which future premiums can be taken into account, and the allowance to be made for
        future expenses can mean that technical provisions will be broadly comparable from
        company to company.

        The position for non-life business is different in that the uncertainty surrounding the
        amount and timing of claims will often be significant, with the effect that differences in
        assumptions on discounting and expenses will have a relatively minor effect on the level
        of provisions.

        The purpose of many valuation rules, such as the restriction on discounting non-life
        outstanding claims, is to ensure that the estimate of liabilities is conservative. These rules
        therefore act as a supplement to the solvency margin requirements.

        Valuation rules could also be used to improve comparability between companies and to
        ensure that the basis of calculating liabilities is consistent with the rationale of the
        solvency margin calculation. At present, there are considerable disparities between
        companies in the strength of their provisions. In particular, there is a wide divergence of
        practice regarding the confidence level that should be aimed for when establishing non-
        life provisions. One approach is to set the provisions at a “best estimate”, i.e. a provision
        where the probability that claims will be greater than estimated is the same as the
        probability that they will be less than estimated. Another approach is to make a provision
        which will be adequate in all reasonably foreseeable circumstances. It is unclear how this
        test could be quantified as a confidence level, but it might be equated with a 95%
        probability that the actual claims will be no greater than those estimated.

        Although it may be difficult in practice to quantify the confidence level that can be
        attached to a particular level of provision, there is no reason why regulations should not
        seek to harmonise the level which reinsurers should aim at.

        As with the asset valuation rules, any requirements imposed by the insurance supervisor
        will overlay the existing general accounting requirements. Moreover, like asset valuation
        rules, liability valuation rules could be introduced without necessarily subjecting
        reinsurers to further regulation.




        mk/nb/552                                                                                   89
6.5.7.2 Rules on methods to be used
        An adequate level of technical provisions ensures that the company is able to meet its
        obligations at any time. All of the insurance industry agrees that an insurer’s technical
        provisions should be appropriate and adequate. It should be the same for reinsurer’s
        technical provisions.

        As referred to in the European Directive for insurers, the amount of technical provisions
        must at all times be such that an undertaking can meet all liabilities arising out of
        insurance contracts as far as can reasonably be foreseen. Any assessment of the adequacy
        of a reinsurer’s technical provisions should have this definition as a basis. In addition, the
        special features of reinsurance business could be taken into account in respect of:

        § underwriting risk;

        § credit risk;

        § currency risk;

        § investment risk;

        § timing risk;

        § globalised risk portfolio.

        It should establish methods of control for ensuring the adequacy of technical provisions,
        based on the best actuarial methods used by reinsurers (see also chapter 9). Usually the
        methods are similar to those applied to direct insurance business and in some cases are
        identical, as in the case of proportional reinsurance.

        Monitoring of technical provisions is an important point for supervision of reinsurers as
        information provided to the reinsurer is of lower quality than information available to
        direct insurers. The reinsurer depends on reports from the direct insurer which usually do
        not include the historical information related to the reinsurer’s portfolio. For non-
        proportional business, provisions for IBNR claims might not be reported. Because of the
        international nature of the business, the reinsurer has to take into account the international
        different accounting policies for reserving, for example there are countries where claims
        provisions are discounted. Therefore, it is essential for a professional reinsurer to do a
        reserve analysis based on its own portfolio including a calculation for IBNR reserving.

        Some associations, such as the CEA, consider that there should be an additional standard
        whereby the respective home supervisory authorities would be obliged to check the
        global adequacy of the technical provisions and would need to have the necessary powers
        to perform these checks.

        Generally, the regulatory returns regarding the level of technical provisions required by
        supervision authorities are in the same form and level of detail as for direct insurers.
        However, in some cases, such as in Switzerland, the rules on calculation and evaluation
        of technical provisions for direct insurers do not apply to reinsurers.

        Property and casualty provisions are in practice calculated using actuarial projection
        techniques using paid and incurred loss development triangles.




       mk/nb/552                                                                                   90
        Life provisions are calculated using actuarial analysis under the policy premium method,
        whereby all anticipated future cash inflows and outflows from a policy are estimated and
        adjusted to present value, with appropriate margins for adverse deviation, to arrive at the
        provision for future policy benefits.

        Regarding non-life provisions, in some countries reinsurers are required to provide
        disclosure of the variability in estimates from prior years claims, which many provide by
        showing data on the over and under provision adjustments made in the current year’s
        income from prior year’s reserves. In addition, schedules showing run-off by accident
        year are required in the statutory return filed with the regulator only. Reinsurers have
        tended to provide little or no explanation for run-off results.

        The effects of significant changes in actuarial assumptions are required to be quantified
        and disclosed in the accounts. Examples of these include changes in the interest rate
        environment, and changes in the policy lapse rate or similar actuarial assumptions.

        A possible approach is to give the supervisor the authority to prescribe standards for
        establishing technical provisions and to verify the sufficiency of these provisions and to
        require them to be increased if necessary. Another possible approach is for reserving to be
        checked by the supervisory authority independently.

        Given the differences that exist between the books of business of different reinsurers, it
        would be unlikely to be practical or appropriate to set rules on the methods of estimation
        to be used. Moreover, the stipulation of particular methods might inhibit the development
        of better techniques for estimating liabilities.

        However, it would be feasible, and not particularly onerous, to require companies to
        disclose in their annual reports the types of techniques it uses to determine the liabilities
        of its principal classes of non-life business.

6.5.7.3 Certification by loss reserving specialist
        Virtually all countries have a requirement for the life provisions of a direct insurer to be
        certified by a qualified actuary and in countries where reinsurers are supervised this
        requirement is extended to reinsurers. In practice, life reinsurers will almost certainly
        already be obtaining a report on their provisions from an actuary and the introduction of a
        regulatory requirement for reinsurers would be a codification of existing practice.

        For example, in the UK, USA, Canada and Australia life reserves both for direct and
        reinsurers have to be certified by an actuary. Non-life reserves and DAC have to be
        certified by an actuary in Canada at present and in Singapore, Australia and Ireland in the
        near future. However, the appointed actuary in Canada is not required to be as
        independent as an auditor and commonly is an employee of the insurer or reinsurer, and
        therefore the external auditor needs to assess the work of the actuary in forming an
        opinion on the financial statements. Lloyd’s of London for solvency purposes require an
        actuarial sign-off which includes a review of reinsurance security based on ratings
        produced by the rating agencies.




        mk/nb/552                                                                                  91
        For non-life business, it would in principle be possible for supervisors to require
        companies to obtain a report from a loss reserving specialist on the adequacy of reserves.
        The rationale for such a requirement would be, that it could help in reducing the risk that
        the provisions may be understated in the financial statements. However it is questionable,
        whether the potential benefits would compensate for the additional corresponding costs.

        Furthermore, there would be practical difficulties in introducing such a requirement in the
        EU either for direct insurance or reinsurance. Unlike the USA and Canada, there is not a
        large and well established non-life actuarial profession and in the short and medium term
        there would not be sufficient people with a recognised loss-reserving qualification to
        carry out the certification.

6.5.8   Capital adequacy and solvency

6.5.8.1 Statutory minimum solvency margin requirements
        The adequacy of financial resources is one of the most important elements in controlling
        an insurer’s and reinsurer’s security. It ensures its ability to fulfil its commitments at any
        time. The assessment of solvency is a key tool for many regulators. Failure by a company
        to meet minimum capital or solvency requirements is a primary warning indicator for
        most regulators.

        Elements of the current solvency system in the EU Directives could be used for
        reinsurers. However, it should be borne in mind that some of the actual methods used
        may not be efficient due to the complexity and international nature of reinsurance
        business.

        Solvency requirements focus on the financial statements and even for direct insurers may
        lead to stronger requirements for prudent companies. Generally companies with a prudent
        reserving policy will need more investments to meet solvency rules although the risks
        they have assumed may not differ from those assumed by a company which has less
        prudent reserves. The technical provision for life business, for example has to be covered
        with investments. As this provision is discounted the amount decreases with any increase
        in the interest rate used. The economic risk for the company increases with the increase of
        the interest rate so that the solvency requirements develop reciprocally to the risk of the
        company.

        In many EU countries the solvency system is considered inadequate. A far reaching
        financial risk model which is based on a general solvency theory and which could
        guarantee the financial position of insurers is not yet available. Due to the fact that the
        financial indicators are calculated from financial statements the judgement about the
        present solvency system is based on past, not forward-looking, information. Furthermore,
        the present solvency system does not take into account the asset management risk of non-
        life insurers. For life insurers the asset management risk is only addressed through the
        amount of the total investments and without examination of the different types of risks
        associated with the assets.

        Part of the industry argues that standardised solvency requirements are easy to implement
        and monitor, but ignore the individual risk profile and risk management approach, are
        retrospectively oriented and exaggerate capital requirements and are only for companies
        unable or unwilling to develop an internal risk model.




        mk/nb/552                                                                                  92
Additional solvency requirements may be proposed, such as those which would relate to
the investments to compensate for the assets risks. In non-life business special attention
would have to be given to the possible inadequacy of long-tail business provisions. To
assess the real risk volatility of a business some model, such as a risk-based capital model
may be used.

The solvency calculations in many countries are based on the EU directives. One
approach would be for the reinsurer to perform the same solvency calculation as a direct
insurer.

The following methods are used to calculate the solvency margin:

First the amount of equity required as a safety margin is calculated based on defined, risk-
weighted margin factors set by the regulator for each asset and liability, including off-
balance sheet exposures; then this total required is divided into the amount of capital
actually available to arrive at a definite ratio. The regulator requires an overall margin
above a 100% ratio, which has been escalating in recent years, and pays more attention to
companies below 150%.

An alternative approach is to define required assets as the book value of liabilities, plus a
specified safety margin for claims and unearned premiums (the margins are increased if
claims experience has been relatively high), and divided into the adjusted assets for the
regulators ratio. Adjusted assets include investments at market value and exclude certain
assets such as computer equipment. The regulator expects a margin of adjusted assets
over the required amount of at least 10%.

Some countries, such as the UK, argue that, although solvency problems in a reinsurer
affect the ultimate consumers of insurance only indirectly, the greater potential for
volatility in the results of reinsurance business (especially non-proportional) suggests that
a degree of supervision at least equal to that of direct insurance is appropriate. The EU
Commission’s current proposals for reform of direct insurers’ solvency margin
requirements include a proposal that a 50% uplift be applied to marine, aviation and
general liability business. It may be appropriate for this, or a higher percentage, to be
applied also to proportional reinsurance business of these classes and all non-proportional
reinsurance business. This would reflect the following factors in such business: greater
volatility, the effect of catastrophes, the longer tail nature of the claims run-off and the
uncertainly in establishing technical provisions. However, we believe that this view does
not reflect the diversification potential and other risk mitigation techniques of reinsurers.

Generally, the regulatory returns regarding the solvency margin required by supervisory
authorities are in the same form and level of detail as for direct insurers. In some cases, as
in Switzerland, there is no solvency requirement required by law for reinsurers, but the
regulator applies a benchmark of 20% of net premium as a minimum equity requirement.
In other cases, as in France, reinsurers are not required to prove their solvency position to
the regulator. In Germany, although there is no statutory solvency margin requirement,
the supervisor tries to ensure that reinsurers have a minimum capital of 10 per cent of net
premiums. In the UK, the basic system of regulation is the same for reinsurers and direct
companies, but some detailed provisions are different.




mk/nb/552                                                                                  93
        Solvency requirements change nowadays from a single company view to a view of the
        whole insurance group. Further developments are shown in the “Study into the
        methodologies to assess the overall financial position of an insurance undertaking from
        the perspective of prudential supervision”.

        Risk-based capital methods could be technically justifiable, but for the regulator these
        methods are difficult to apply since they presuppose a strong knowledge of management
        control and of the risk portfolio of the reinsurer. Risk-based capital methods are discussed
        in more detail in the “Study into the methodologies to assess the overall financial position
        of an insurance undertaking from the perspective of prudential supervision”. A possible
        approach to supervision could be the definition of standards that have to be covered by
        the risk-based capital method. If these standards are not met the supervised companies
        have to demonstrate their solvency by the common method based on ratios.

6.5.8.2 Resilience and scenario testing
        Resilience testing is well established for direct life business where companies are
        required to consider the impact of sharp falls in investment values and interest rates.
        Jurisdictions which regulate reinsurance companies also apply such tests to life
        reinsurance companies.

        To date supervisors have not generally extended the principle of resilience testing to other
        areas; for example it could require companies to disclose the impact of a 10% adverse
        deviation from expected loss ratios or to require that the solvency margin was sufficient
        to withstand an adverse deviation of this magnitude. Resilience testing may represent an
        alternative approach to calculating minimum solvency requirements which avoids the
        inflexibility of formula-based approaches.

6.5.8.3 Equalisation and catastrophe provisions
        EU regulation requires non-life direct insurers to establish equalisation provisions for
        credit business. Some member states have extended these requirements to other classes of
        business that are inherently volatile such as frost and hail. Catastrophe reinsurance
        business is similar in nature to these classes of direct business in that there are expected to
        be occasional years of heavy losses balancing most years when profits are made.

        Equalisation provisions should be extended to reinsurance business. Reinsurance business
        often tends to be more volatile than direct insurance business for the reasons given in
        chapter 2. However, it is not the objective of equalisation provisions to smooth out
        volatility in general rather than to depict fairly the equalisation process over time taking
        place in the insurance business. Therefore, there is no higher need for an equalisation
        provision for reinsurance business than for direct insurance business.

        By contrast, the concept of catastrophe provisions is important with respect to the
        reinsurance business. Reinsurers are to a significantly higher extent exposed to
        catastrophe risks than direct insurers. They tend to build in the ability to take a major
        shock periodically and the capital needs to be adequate for this.




        mk/nb/552                                                                                   94
         Concerning catastrophe risks, it is unlikely or it may even not be possible at all to
         diversify the different risks within a portfolio of contracts during a single a  ccounting
         period, especially when the likelihood of occurrence of such risks is relatively low, but
         the volume of the potential cost of each of these risks is individually high. For example
         for earthquakes, the relevant extreme losses have return periods of about 200 years and
         these losses can arise out of only about 10 scenarios of comparable size. As a result, the
         typical insurance principle to balance losses within a large portfolio cannot be applied
         here. In such cases, it must be the aim to diversify the different risks over a period of
         time, i.e. the time span for covering claims expenses with revenue extends beyond a
         single accounting period into an unlimited period in the future.

         The necessary coverage of the insured risks over time can only be achieved, if the risk
         premiums which are not used for claim expenses are carried forward to later accounting
         periods. It must be deemed that the insurance enterprise has an obligation at the reporting
         date.

6.5.9    Market conduct
         Countries which regulate reinsurance companies do not subject them to their market
         conduct rules since they do not deal directly with members of the public.

6.5.10   Financial reporting
         Reinsurance companies are already subject to the general requirement to produce annual
         accounts. Supervisors may also require more detailed information or for the reporting to
         be more frequent and to tighter timescales. The basic rationale for applying more
         stringent reporting requirements to insurance and reinsurance companies than the
         generality of companies is two-fold:

         § to enable the supervisor to assess the financial strength of the companies supervised;
           and

         § to enable buyers of insurance and reinsurance to assess the financial strength of
           potential providers of cover.

         In addition, reporting assists the supervisor in monitoring compliance with other
         parameters, such as conformity with business plans, and diversification of investments.

         It would be possible to introduce additional harmonised reporting without subjecting
         reinsurers to full direct supervision. There would, however, need to be sanctions which
         could be imposed on companies which failed to comply with the reporting requirements.




         mk/nb/552                                                                               95
         The present lack of an international method for accounting for the insurance and
         reinsurance sector may hinder the supervision of parameters at an EU and/or international
         level. There are different bases under which the assets and liabilities arising from
         insurance and reinsurance contracts are measured and reported and the results of such
         transactions are calculated (an overview is given in chapter 5). Although, under European
         legislation, an effort has been made to ensure that the accounts of member insurers and
         groups are prepared on a consistent basis, limitations already exist due to the wide range
         of options available under the legislation and a lack of harmonised guidance on the
         policies. A harmonised framework of accounting practices could promote greater
         comparability and transparency and provide relevant and reliable information to
         supervision authorities.

         Uniformity in assessing the reinsurer’s security will be essential to a world-wide
         acceptance of a system of reinsurance supervision, with converging supervisory
         principles and standards. This objective can only be achieved with harmonisation of the
         information on reinsurers, namely by regulation of accounting standards. The use of
         future harmonised standards for supervisory issues is discussed in more detail in the
         “Study into the methodologies to assess the overall financial position of an insurance
         undertaking from the perspective of prudential supervision”. Usually, reporting
         requirements for reinsurance companies are not so detailed as for direct insurance
         companies.

         Generally reinsurance companies generate their financial information from data provided
         by cedant companies. Because of the international nature of the business there is always a
         delay in receiving the information or, if financial statements are prepared soon after the
         balance sheet date, there could be a lack of quality because a high degree of estimation is
         needed. In particular, the claims reserves are subject to estimates. This causes estimated
         amounts in reinsurance receivables and payables as well as in profit-sharing. For
         proportional business, premiums also have to be estimated. Finally, the profit for the year
         is influenced by estimates. There is a trend to producing financial statements more
         promptly as a result of pressure from the capital markets. Therefore the impact of
         estimations increases.

         To keep the quality of the financial statements, in practice, sophisticated estimation
         systems are designed for the companies. To give a judgement of the quality of these
         estimates, these systems have to be analysed. However, even if the implemented
         estimation system meets the highest standards, misstatements caused by the lack of
         information are common and have to be reflected as an adjustment in the next period.

         Supervision of reinsurance should take this aspect into account. Financial supervision of
         reinsurance companies may not need to be as extensive as for insurance companies.

6.5.11   On-site inspections

6.5.11.1 Inspection by the supervisor
         On site inspection is not merely a supervisory parameter. It represents a distinct approach
         to supervision, one in which the regulator takes an active role in monitoring the activities
         of a company and its compliance with the regulations.




         mk/nb/552                                                                                96
        On site inspections enable supervisors to:

        § evaluate the management and internal control systems;

        § analyse the company’s activities;

        § evaluate the technical conduct of the business being carried on, such as the
          organisation and management of the company, its commercial policy, and its
          reinsurance cover and security.

        These activities are time-consuming and require a technical knowledge of a complex
        business. On the other hand, on-site expections allow the supervisory staff to extend its
        experiences which are necessary for an effective off-site supervision. The issue with on-
        site inspections is whether supervisors have sufficient resources to carry them out.

6.5.11.2 Inspection by third parties, such as auditors
        In many cases, the objectives of on-site inspection can be achieved by requiring auditors
        or other third party experts to investigate and report on companies.

        Auditors will already be considering the adequacy of controls and provisions as part of
        the statutory audit so that extending these requirements might be a more feasible and
        cost-effective approach than the extensive use of on-site inspection by the regulators
        themselves.

6.6     Parameters relating to indirect supervision
6.6.1   Direct review of reinsurance programme
        As defined by the IAIS in the Insurance Core Principles, the insurance supervisor must be
        able to review reinsurance arrangements to assess the degree of reliance placed on these
        arrangements and to determine the appropriateness of such reliance. Insurance companies
        would be expected to assess the financial position of their reinsurers in determining an
        appropriate level of exposure to them. IAIS asks the insurance supervisor to set
        requirements with respect to reinsurance contracts or reinsurance companies addressing:

        - the amount of the credit taken for reinsurance ceded. The amount of credit taken
          should reflect an assessment of the ultimate collectability of the reinsurance
          recoverables and may take into account the supervisory control over the reinsurer; and

        - the amount of reliance placed on the insurance supervisor of the reinsurance business
          of a company which is incorporated in another jurisdiction.

        The supervisor has to ensure that the reinsurance programme is appropriate to the level of
        capital of the insurer and the profile of the risks it underwrites and that the reinsurer’s
        protection is secure.




        mk/nb/552                                                                                97
The Australian Prudential Regulation Authority (APRA) also recommends a system
based approach in supervising the reinsurance arrangements of insurers. This approach
recognises primary responsibility for reinsurance management rests with the board and
senior management of an insurer and focuses on the quality of the processes and controls
adopted by that insurer. Reinsurance management is a critical component of an insurer’s
ability to meet policyholders obligations.

The objective of such an examination is for the cedant to make sure that the chosen
reinsurance undertakings, the professional reinsurers as well as the direct insurers writing
inward reinsurance, offer the best possible guarantee that they will be able to fulfil the
obligations they have accepted.

The monitoring of these reinsurance programs is often less strict than supervision of
direct business and in many cases simply requires copies of treaties and other contractual
documents and the list of reinsurers to be submitted to the supervisory authority.
Submission of these documents focuses on ensuring observance of technical and financial
requirements rather than evaluating the market conditions of reinsurance contracts.

Requiring insurance companies to report details of their exposures and reinsurance
arrangements may encourage management to be more rigorous in devising appropriate
reinsurance programmes.

Such security analysis is not always successful, either because of the lack of necessary
data to serve as a basis for assessment or because of the inability of the ceding company
to use the available data to obtain an appropriate assessment of the reinsurers. In this
respect, insurance supervisory authorities can play a role in exercising some control over
the choice of reinsurers by the ceding companies to ensure the good security of chosen
reinsurers.

If the ceding company does not obtain all the information necessary to get a
comprehensive overview of the reinsurer, the examination cannot be appropriate. Also,
the ceding insurer may not have the capacity to carry out a proper assessment of the
reinsurer. However, examining the reinsurance protection of the direct insurer is useful
when reinsurance companies are unable to provide information for reasons of client
confidentiality and if foreign reinsurance companies and/or their branches are not
supervised in their domestic country.

This parameter of indirect supervision has the advantage of reducing the scope of
supervision. Such an approach can transfer the cost of monitoring the security of foreign
companies to the foreign reinsurers interested in operating in the domestic market. But
this indirect supervision parameter brings with it disadvantages such as administrative
costs for cedant companies in providing the information.

A system in which it is the primary insurer’s responsibility to assess the reinsurer’s
security may not be totally secure. The ceding insurer will be motivated by the desire to
minimise cost as well as to maximise security. For financial reasons the ceding insurer
may choose a secure reinsurer, but not necessarily the most secure 27 .



27
     Reinsurance and reinsurers: Relevant issues for establishing general supervisory principles,
     standard and practices, February 2000




mk/nb/552                                                                                           98
        The industry is of the opinion that the review of reinsurance programmes is a
        fundamental part of supervising the reinsurance market. Assessment of reinsurer security
        is a function of the direct insurer, and supervision authorities must monitor the
        appropriateness of the protection of the direct insurer by the reinsurer.

        In some EU member states the techniques used to assess the reinsurance programme of an
        insurer are generally based on data from financial statements and other available
        information (e.g. Germany) or in some cases based on on-file and on-site audits (e.g.
        France), but in many cases there is no evidence that the regulator supervises the
        reinsurance programme beyond an analysis of the documentation which has to be
        submitted. In Switzerland no special focus is given to this area by the regulator.

        In some countries, for example in France, the information required with respect to
        company’s outwards reinsurance programme is quantitative and does not provide the
        regulator with a view on the quality of the reinsurance programme.

6.6.2   Limits on maximum exposures
        Assessments of the adequacy of an insurer’s reinsurance protection need to be made in
        the context of an insurer’s maximum exposure. For example, a company might have a
        working rule that it will not expose itself to a loss from a single event of more than 5% of
        its capital. Clearly such limits will vary greatly from company to company depending on
        the scale and diversity of the insurance business that they write. Any potential loss in
        excess of such a limit would need to be protected by reinsurance. In practice, many
        supervisors have informal internal guidance on what are appropriate maximum exposures.
        It may be possible to develop this guidance into harmonised rules on the maximum
        exposures that companies may accept relative to their capital.

6.6.3   Admissibility of reinsurance assets for the primary insurer
        Reinsurance recoveries are hard to quantify as their estimation depends on the estimation
        of losses during any given period.

        The Prudential Supervision of General Insurance Companies in Australia (APRA)
        proposed that the minimum statutory solvency requirement should take into account the
        relative riskiness and diversity of reinsurance, in deciding whether, and to what extent,
        these assets should be allowed to count towards an insurer’s statutory solvency
        requirement. It recommended the consideration of a system of risk weighting the assets of
        insurers, reinsurance assets be risk weighted according to ratings assigned by rating
        agencies. More information was sought on how risk weights would be applied to
        reinsurance assets such as those relating to incurred but not reported claims liabilities
        where it was uncertain which reinsurer would be called upon.

        The pool of reinsurance recoveries would be risk weighted according to the risk-weighted
        average of premiums ceded in the previous reporting period.




        mk/nb/552                                                                                99
        This proposal uses the same general principles in the risk weighting of reinsurance assets
        for insurers as those proposed in June 1999 by the Basel Committee on Banking
        Supervision 28 . The proposed reforms include the introduction of credit risk weights based
        on the ratings assigned by rating agencies.

        Further developments will be shown in the “Study into the methodologies to assess the
        overall financial position of an insurance undertaking from the perspective of prudential
        supervision”.

6.6.4   Credit for reinsurance and collateral requirements
        Credit for reinsurance concerns the deduction of reinsurance in the calculation of the
        solvency margin. The admissibility of reinsurance recoverables for the determination of
        required minimum regulatory capital has been addressed in the previous sub-section.
        Collateralisation concerns the reduction of the reinsurers’ credit risk through security
        deposits. Collateral requirements may also affect the calculation of the solvency margin
        of the primary insurer. According to EU rules, the solvency margin allows just 50% of the
        receivables against reinsurers if there is no deposit.

        Credit for reinsurance is given either by increasing the assets or reducing liabilities. To
        qualify for credit, ceding insurers must meet certain supervisory requirements. These may
        include the holding of collateral to secure the obligation or the constitution of a trust fund
        if reinsurance is not ceded to a reinsurer licensed in the home country of the insurer.

        One disadvantage of credit for reinsurance with regard to the calculation of the solvency
        margin is that reinsurance recoverables are based on past claims while the solvency
        margin is supposed to put the reinsurer in the position to cover future claims. Therefore, it
        has to be noted that reinsurance recoverables can only be an approximation of risk
        reduction provided in the future.

        Collateral requirements can enhance the domestic supervisor’s comfort level with the
        reinsurer’s ability to meet its financial obligations to ceding insurers and their requisite
        policyholders.

        There are a number of disadvantages: collateral for the benefit of certain classes of
        policyholders may act to the detriment of other classes of policyholders. Collateral
        requirements create classes of preferential creditors and can lead to capital withdrawn
        from the local markets. For many users these restrictions are seen to have the effect of
        dispersing a reinsurer’s capacity and thereby hindering its freedom to trade. Finally, the
        rates of return on deposits held by ceding companies are often far lower than would
        actually be earned by reinsurers on these funds, and the practice of requiring deposits
        actually increases the cost of reinsurance (leading to higher premiums).

        Part of the industry argues that with this mechanism of protection, no additional
        supervision is needed for reinsurers.




        28
             Consultative Paper “A New Capital Adequacy Framework”




        mk/nb/552                                                                                 100
Some supervisory authorities have always held that gross reinsurance technical reserves
must be covered by assets which meet strict criteria. In those cases, reinsurers must make
appropriate deposits or pledges in favour of cedants to enable the direct insurers to meet
regulatory liabilities coverage constraints, for example in France. According to the French
authorities, this practice adequately protects cedants against default by their reinsurers
and is the only available proof that the reinsurer agrees with the cedant’s computation of
reinsurance recoverables.

It is argued that, considering the difficulties in controlling reinsurance, this system is at
the moment the only one which allows an efficient protection against reinsurer default.
Abandoning such a system would only be possible if the new system could give the same
level of protection for insurers. The system of control over reinsurers would need to be
sufficiently harmonised and coordinated at an international level and would involve the
exchange of confidential information about ceded business.

Within the EU, France, Belgium and Spain use indirect deposits by “gross reserving”. In
Belgium, exceptions have to be approved by authorities. In the US, trust funds are used or
other collateral under State credit for reinsurance laws.

The US has developed a system whereby the reinsurance transaction is regulated through
the mechanism of credit for reinsurance. The fundamental concept underlying the US
regulatory view is that the reinsurer must either be licensed and subject to the full
spectrum of reinsurance regulation or provide collateral to ensure the payment of the
reinsurer’s obligations to US ceding insurers (through a trust, letter of credit or other
acceptable security) 29 .

The idea behind this approach is that the ceding insurer is allowed financial statement
credit for cessions to non-US reinsurers, only if US regulators have the confidence that
the non-US reinsurer is able and willing to pay its obligation to US ceding insurers as
they become due. This is accomplished through the collateralisation of the reinsurers’
obligations.

According to US authorities, collateralisation eliminates the regulator’s need to assess the
level of regulation in the non-US reinsurer’s domiciliary jurisdiction or the financial
strength of the particular reinsurer. Collateralisation ensures that funds are available to
satisfy the non-US reinsurer’s obligations whether it is solvent or not. Collateralisation
also serves to ensure that funds are available in the event that the ceding insurer becomes
insolvent. Cost and difficulties are mitigated or even eliminated if sufficient collateral is
provided to satisfy the obligations of the reinsurer.

European reinsurers are pressing for a less stringent regulatory system in the US that
would benefit them. They argue that US regulators have established deeper and broader
working relationships with foreign insurance regulators and have a better understanding
of the solvency regulation of many foreign countries. European reinsurers believe it
would be appropriate to reassess the US credit for reinsurance rules, particularly as they
relate to cessions of reinsurance by US reinsurers to non-US reinsurers. They believe that
it would be appropriate to reduce the level of funding required for the multi-beneficiary
reinsurance trusts maintained by a number of these reinsurers. Today European reinsurers
operating in the US are highly-rated, professional reinsurers dealing with sophisticated

29
     Reinsurance Association of America, Alien Reinsurance in the U.S. Market 1996 Data




mk/nb/552                                                                                 101
        buyers. A mutual recognition where reinsurers regulated in the EU are free to trade within
        the US and vice-versa, would facilitate free trade and competition at an international
        level. This would also reduce the bureaucracy involved in trading in the US and help to
        create a free and transparent market in reinsurance. The IUA has been working on a
        project with the objective of reducing trust fund requirements for overseas reinsurers. In
        March 2001 some progress had been made, when the NAIC agreed to the concept of
        irrevocable letters of credit being used as an allowable asset. This allows a system with
        greater flexibility and improves the reinsurer’s cash flow, but it is only a small step
        forward.

        Today most of the professional reinsurers handle the problem by establishing a subsidiary
        in the US which is subject to supervision, so that there are no obligations for non resident
        reinsurers.

6.6.5   Diversification requirements
        Supervisors can reduce the reinsurer default risk by placing limits on the amount of credit
        that can be taken for reinsurance with any one reinsurer.

        In general, EU regulators have not enshrined diversification requirements in legislation.
        This reflects the fact that there are great differences in the types and amount of cover
        obtained by direct insurers.

6.6.6   Use of rating agencies
        As part of an insurer’s assessment of the credit-worthiness of a reinsurer, there is
        normally a significant reliance on the ratings provided by rating agencies. Credit ratings
        are also important in the context of primary insurance companies, but tend not to be used
        extensively where private consumers are concerned, due to the protection afforded by
        guarantee schemes and existing solvency supervision in many territories.

        From a supervisory perspective, this difference is of relevance because there may be
        scope for supervisory authorities to make greater use of the market mechanism which
        exists in relation to credit ratings. Also, downgraded credit ratings will act as signals to
        supervisors, particularly as financial difficulties of reinsurers may in turn result in
        difficulties for insurers, with consequent implications for the protection of policyholders.

        At present, there is no explicit use of rating agencies by the regulator, except as general
        information. But many insurers use rating agency information in their selection of
        reinsurers. Insurers that select only highly rated reinsurers, in conjunction with other
        criteria, are less likely to have problems with uncollectable reinsurance and will spend
        less time and resources evaluating reinsurers 30 .

        Some argue that there will be an extension of their use in response to pressure by
        regulators who will try to upgrade the quality of companies by insisting that they get
        ratings from acceptable agencies.




        30
             Principles of Reinsurance, Insurance Institute of America, p.201




        mk/nb/552                                                                               102
The role of rating agencies is becoming more important. They have already had the effect
of improving discipline in the reinsurance market. Although insurers cannot endorse the
validity of these independent credit evaluations, they do provide a useful indication of the
security of various reinsurers in the global market place.

The supervisor has to be careful in using ratings of reinsurance companies because rating
agencies react slowly to market trends and, as stated by the Groupe Consultatif des
Associations d´Actuaires, history shows that they do not provide timely early warning
signals in case of reinsurance failure. However, it would make sense for supervisors to be
aware of the external ratings.

Part of the industry is of the opinion that companies have to take precautions when using
ratings. The main concern of rating agencies should be the recognition of risk; the risk
cannot be assessed with poor proxies such as premiums, but refined exposure measures
are required for adequate risk assessment. Some argue that solvency control through
supervisory authorities would be preferred to ratings. Rating agencies are in the business
for commercial reasons and any involvement in supervision would conflict with this.
Where the regulator does have recourse to ratings, an acceptable rating level should be
established (for instance BBB by Standard & Poor’s).

From a rating agency point of view, reinsurance company ratings are used by
brokers/intermediaries banks and equity analysts and are serving policyholders and the
cedants. Rating agencies provide benefits to management control and to companies which
can compare themselves with their peers. In their opinion, they are an early warning
system for regulators by providing ratings on reinsurance recoveries and insurance
companies. They point out that there could be a conflict of interest, when companies pay
for ratings which the supervisor would be using to regulate them, similarly when
insurance companies look at claims payment ratings of reinsurers (paid for by the
reinsurer). At the moment this is a commercial decision. However, it could become more
serious if regulators use rating agencies.

The main agencies on the market are A.M. Best Company, Standard & Poor’s
Corporation Moody’s Investors Service and Fitch IBCA/Duff & Phelps Credit Rating
Corp. They provide credit ratings for insurance companies worldwide and also rate the
major reinsurers. They generally have their own models based primarily on historical
financial analysis and capital adequacy statistics. A brief overview of the methods used
by these agencies is presented below.

Best’s ratings are based on a comprehensive evaluation of a company’s financial strength,
operating performance and market profile against A.M. Best’s quantitative and qualitative
standards. The quantitative evaluation is based on an analysis of each company’s reported
financial performance for at least the five past years, using over 100 key financial tests
and supporting data. These tests, which vary in their importance depending on a
company’s characteristics, measure a company’s absolute and relative performance in
three critical areas: leverage/capitalisation, profitability and liquidity. A company’s
quantitative results are compared with standards of its peer composite as established by
A.M. Best for property/casualty and life/health insurers. Peer standards are based on the
performance of many insurance companies with comparable business mix and size. In
addition, industry composite benchmarks are adjusted annually for underwriting,
economic and regulatory market conditions to ensure the most effective and appropriate




mk/nb/552                                                                               103
analysis. The interpretation of these quantitative measurements involves incorporating
more judgemental, qualitative considerations into the process 31 .

A Standard & Poor’s Insurer Financial Strength Rating is a current opinion of the
financial security characteristics of an insurance organisation with respect to its ability to
pay under its insurance policies and contracts in accordance with their terms. Standard &
Poor’s employs two approaches when rating the financial strength of insurer: interactive
ratings, and “pi” ratings. The difference between the two reflects the amount and type of
information the analysts are expected to receive. Interactive financial strength ratings are
published only after a thorough review, which includes an extensive interview with the
management. The “pi” subscript indicates that the insurer has not voluntarily subjected
itself to Standard & Poor’s most rigorous review. Therefore, the analysis is based on an
insurer’s published financial information and other data found in the public domain 32 .

A Moody’s Insurance Financial Strength Rating assigned to an insurer measures the
ability of that company to punctually repay senior policyholder obligations and claims.
These ratings are based on industry analysis, regulatory trends, and an evaluation of a
company’s business fundamentals. Industry analysis examines the structure of
competition within the company’s operating environment and its competitive position
within that structure. Analysis of regulatory trends attempts to develop an understanding
of potential changes in a particular country’s regulatory system, accounting system, and
tax structure. The analysis of a company’s business fundamentals focuses primarily on
franchise value, management, organisational structure/ownership, and financial analysis.
The financial analysis includes an assessment of capital adequacy, investment risk,
asset/liability management, profitability, liquidity, underwriting, reserve adequacy, and
financial leverage 33 .

A Fitch insurer financial strength rating (IFS rating) provides an assessment of the
financial strength of an insurance organisation, and its capacity to meet senior obligations
to policyholders and contract holders on a timely basis. Fitch’s analyses incorporate an
evaluation of the rated company’s current financial position as well as an assessment of
how the financial position may change in the future. Consequently, the rating
methodology includes an assessment of both quantitative and qualitative factors based on
in-depth discussions with senior management. Fitch’s insurance ratings generally include
an approximate 60% quantitative and 40% qualitative element through such weightings
can vary drastically given unique circumstances. The company’s ability to meet its
obligation is evaluated under a variety of stress scenarios, not just the “most likely”
scenario. Incorporated into the analysis is a review of the company specifically, as well as
the macro trends affecting the industry in general. Rating methodology focuses on the
industry review, operational review, organisational review, management review and
financial review34 .




31
     Best’s Key Rating Guide, Life and Health Edition
32
     Standard & Poor’s Property/Casualty Insurance Ratings Criteria
33
     Moody’s Rating Methodology Assessing Credit Risks of US Property and Casualty Insurers
34
     Fitch Non-Life Insurance Ratings Criteria




mk/nb/552                                                                                 104
        Analysis of reinsurance companies, as pointed out by Standard & Poor’s, must be
        continually reinvented in order to be reflective of the expanding boundaries and
        innovative approaches of “non-traditional” reinsurance mechanisms, like the emergence
        of alternative market mechanisms; the gradual diminution of true risk transfer embodied
        in finite risk reinsurance; the connection of reinsurance with financial markets in the
        securitisation of various type of risks. The issue of reinsurance recoverables remains a
        significant one for the reinsurance industry and is focused on the ultimate collectability of
        retroceded liabilities.

        Generally, the major players in the reinsurance market are rated by the major
        international agencies. Most smaller companies do not engage a rating agency. Generally,
        no use of ratings is made by the regulator.

        For the implementation of a framework of supervision of reinsurers the reliance on rating
        agencies is a possible approach. On the one hand this approach does not give rise to high
        costs, but on the other hand the judgement of rating agencies is driven by subjective
        considerations. The reinsurer and the supervisory authority have no influence on the
        subjective elements of a rating.

6.6.7   Restrictions on use of non-regulated reinsurers
        At present this issue is greatly influenced by the fact that many of the largest and
        strongest reinsurers are currently unregulated or only regulated to a relatively limited
        extent. The two largest reinsurers, Munich Re and Swiss Re, have some 20% of the
        reinsurance market between them, and both have the highest security ratings. Of the ten
        largest non-life reinsurers, five are regulated to a relatively limited extent only (Munich
        Re and Swiss Re plus Gerling, Allianz Re and Hannover Re). In such circumstances, it is
        impractical for supervisors to restrict the extent to which direct insurers place reinsurance
        cover with unregulated reinsurers.

        However, if the EU introduced a regulation requirement for reinsurers, it could become
        possible for EU insurance supervisors to restrict the amount of credit given for
        reinsurance placed with unregulated reinsurers.

6.6.8   Restrictions on use of “unapproved reinsurers”
        Another approach that supervisors could take would be to restrict credit for reinsurance to
        cover from “approved reinsurers” which could include all regulated reinsurers plus other
        unregulated reinsurers which were explicitly approved by the supervisor.




        mk/nb/552                                                                                105
7     The arguments for and against reinsurance supervision
      and a broad cost-benefit analysis

7.1   Scope
      In accordance with the Terms of Reference, this chapter analyses “the arguments for and
      against reinsurance supervision (e.g. contribution towards strengthening the prudential
      supervision of primary insurers, access to global markets by European reinsurance
      companies, etc.)” and provides “a broad cost-benefit analysis of the public policy
      benefits achieved by supervising reinsurers relative to the costs of supervision”.

7.2   Approach
      In reporting on the above objective, we undertook the following approach:

      § Use of existing specialist knowledge;

      § Use of questionnaires to KPMG offices and a number of interviews with reinsurers;

      § Discussions with regulators and use of public information where necessary, to
        supplement information gathered from local offices;

      § Reviews of existing published sources.

7.3   Arguments for reinsurance supervision
      There is one single directive, adopted in 1964, which applies specifically to reinsurance;
      it was intended to abolish regulations which restricted freedom of establishment and
      freedom of services. In practice, its principal effect has been to facilitate the freedom of
      establishment for specialised reinsurers. However, the experience of these three decades
      shows that the freedom ratified by the directive of 1964 no longer satisfies all concerns of
      reinsurers. This directive had left national supervisory authorities the option to implement
      local reinsurance supervision regimes. This has led to a proliferation of national rules on
      reinsurance, often very disparate, which has hindered the creation of a single market.
      Differences in the regulation of reinsurers across EU member states has resulted in a
      distortion of competition of the single market. On the other hand, harmonised supervision
      can create distortion of competition with reinsurance providers from European third
      countries (e.g. US).

      Growing pressure is coming from international discussions between central bankers and
      finance ministries for international reinsurance to be brought more under control.
      Generally, there is a consensus about more supervision. In fact major reinsurers are low-
      regulated or differentially regulated, but the main factor is that globalisation and e-
      commerce are creating an international flow of capital. But there has been no empirical
      evidence of any systemic risks (see section 3.4 for the definition of systemic risk) caused
      by or in connection with the reinsurance sector35 .

      35
           Financial Stability Forum, Report of the Working Group on Offshore Centres, April 2000,
           p.15




      mk/nb/552                                                                                      106
EU harmonised market

Enhanced regulation of reinsurers is part of an inexorable trend towards regional and
global coordination of the conduct of financial services business generally. Within
Europe it is an anomaly that the direct insurance market should benefit from a level
playing field while the reinsurance market, which serves it, remains subject to trading
barriers within the EU, contrary to the principles of free movement of capital and services
upon which it is based. However, reinsurance has historically always been international.
Because of its international nature, a heterogeneous system of supervision within the EU
or even world-wide may lead to impediments and distortion of competition.

A level playing field in the regulation of reinsurance in Europe is proposed by many
associations such as the IUA or the CEA, which could be achieved by the implementation
of a mutual recognition system such as a single passport. For the IUA the objective is for
a European passport for insurance and reinsurance to attain mutual recognition with the
equivalent North-American system.

Such a system would help to eliminate discriminatory treatment and trade obstacles (such
as additional licensing procedures, reporting requirements, deposits or similar
requirements). In a number of countries, the collateral system determines the reinsurance
arrangements where local regulation focuses on the security of the primary insurer. These
requirements have the disadvantage that they result in capital being withdrawn from the
local market. From a reinsurer’s point of view it is argued that such restrictions on the
location of capital unduly hinder the freedom of trade.

Higher reinsurance costs caused by market barriers

Barriers to foreign reinsurers, such as exist at present, increase the cost of reinsurance to
cedants and thus also the cost of insurance to policyholders. They reduce access to the
competitive international reinsurance market which would offer not only lower cost, but
also a better and broader range of services.

For instance the obligations involving letters of credit bring additional costs for
reinsurers.

Indirect additional protection of policyholders

Direct or indirect supervision of reinsurance does not only protect the direct insurer
against failure of its reinsurer, but maintaining stability and confidence in reinsurance
markets through the application of supervision parameters in turn also leads to a higher
degree of policyholder protection.




mk/nb/552                                                                                107
Transparency of the market

The existence of harmonised supervision rules would also improve transparency in the
European industry. Implementation of common accounting standards and practices and
prudential ratios applicable to all is essential to enable operators to establish and
terminate relationships based on a full knowledge of the facts. Transparency of
information in the marketplace facilitates market discipline which in turn maintains
standards of conduct and creates incentives for companies themselves to maintain
standards. However, harmonised regulation can only work with adequate standards and
similar core requirements imposed by each country, to permit free trade anywhere in the
geographical area of mutual recognition.

Market performance

Moreover, supervision could help ensure a strong image and could possibly improve
industry performance. As “unsuitable” reinsurers could be identified more easily and, if
there were an authorisation or licensing system, could be removed from the market the
overall reputation of the market would be enhanced. Regulation may help remove firms
guilty of misconduct from the market that would otherwise contaminate the reputation of
all firms in the market.

Reduction in insolvency risk

In recent years, the reinsurance market has shown a clear trend towards concentration and
an abundance of risk-seeking capital supply. Fraud risks may occur in the complex
markets of risk transfer products because of the insufficiently transparent retrocession
processes. The combination of severe competition and continuous entry of new suppliers
can lead, among other things, to bankruptcy.

Supervision may contribute to limit the risk of fraudulent bankruptcy or default. Even if a
reinsurer’s bankruptcy only rarely leads to insolvency of its cedants, it is important for the
reputation of the reinsurance sector to avoid such occurrences.

Increase in market efficiency

Regulation that could enhance competition and overall efficiency in the market could
create a market which overall works more efficiently and through which everyone could
gain. Competition can result in a transfer from the less to the more efficient reinsurer
which has the effect of increasing the overall efficiency of the market. In this respect,
efficient reinsurers may possibly benefit from meaningful regulation. Regulation can
make competition more effective in the market by requiring the disclosure of relevant
information that can be used by insurers in making informed choices.

Bargaining power against non-EU countries

Supervision could lead to European insurance associations having increased bargaining
power to oblige non-European countries to lower the constraints which still all too often
hamper geographical expansion of reinsurance operations. A common European
framework could also provide European reinsurers with a competitive advantage over
unsupervised non-EEA reinsurers and could thus be used as a marketing tool. But this
obviously depends on the nature and structure of the framework.




mk/nb/552                                                                                 108
      Many European associations believe harmonised supervision could give European
      reinsurers a strong image and a negotiating tool, vis à vis foreign regulators (e.g. US), for
      being considered adequately supervised. Restrictions placed by regulators on foreign
      reinsurers, such as having to keep trust funds in the US, are in fact protectionist in their
      effects.

      Cost savings by harmonised supervision

      Harmonised supervision would reduce the scope for duplication, with only home
      supervision, which would reduce the costs at an EU level. A standard system will lead to
      a saving on the costs of compliance with different legal and regulatory regimes. A system
      built on mutual recognition (i.e. a passport system) in the country where the reinsurance
      undertaking is registered would mean that supervisors in host countries would not have to
      perform additional supervision or checks.

      Capacities of direct insurance industry increase by harmonised supervision

      A recognised harmonised system could mean that more credit could be given for
      reinsurance in the solvency margin calculation for business ceded to EU licensed
      reinsurers. This would mean that the maximum reduction of 50% today might be
      increased in order for direct insurers to rely to a large extent on their reinsurance
      arrangements with EU recognised reinsurers. AISAM strongly considers that the current
      maximum reductions for reinsurance are too low and should be increased to between 90%
      to 100% for all contracts, provided of course that the reinsurer was properly supervised.
      For the Groupe Consultatif, the amount of the solvency margin reduction should depend
      on both the standing and type of cover applied, given the insurer’s portfolio and expected
      new business. Under these conditions regulation increases the capacity of direct insurers.

      Harmonisation allows a lower level of regulation

      Any harmonisation of reinsurance regulations should minimise such regulation as is
      already in place. Even the opponents of reinsurance supervision prefer harmonised
      supervision to the current situation because this would reduce the effort required to fulfil
      different local rules from supervisory authorities. In many countries, there are several
      reporting requirements for foreign reinsurers. The requirements differ from country to
      country, for example in relation to the accounting rules.

7.4   Arguments against reinsurance supervision
      Generally, the reinsurance industry is of the opinion that there is no need for regulation,
      arguing that in several European countries there are low-level regulated markets which
      operate effectively.

      The reinsurance industry also argues that the evaluation of adequate protection and
      security of reinsurance companies is the business of direct insurance. Companies are of
      the opinion that supervision should be based at this level, focusing on whether the
      reinsurance protection of the direct insurer is appropriate.




      mk/nb/552                                                                                109
Professional market

Reinsurance is a professional market. The customers of reinsurers are sophisticated
companies who do not need the same protection as private consumers. In a wholesale
business such as reinsurance, commercial insurers and reinsurers deal with other
professional corporations, business to business, and do not need special protection like
final consumers (policyholders). The view of the IUA is that, this situation means that
reinsurers should be subject to a lower degree of regulation than insurers. For some
professionals, this shows that there is no justification for detailed state supervision.

Practical implementation of supervision

Given the internationality of the reinsurance business and its dynamism and flexibility,
which differs from direct insurance, the practical implementation of national supervision
may be difficult. For example the types of contracts differ from region to region. In
relation to the business which is highly heterogeneous, requirements for reinsurance
supervision are also high.

Global market

Global reinsurance business needs more freedom of action than the direct insurance
business which is usually regionally limited, so that the intensity of supervision should
not be the same for the professional market of reinsurance as for the direct insurance
market.

Market barriers

Regulation, particularly state regulation, brings initial barriers to entry, and can introduce
delays which conflict with business objectives. State regulation is necessary for the
protection of consumers, but reinsurance is a business between sophisticated commercial
undertakings, not consumers.

Impact on effective competition

Reinsurance supervision may have adverse effects on the functioning of the reinsurance
market. Where legislation is deemed necessary it should not create an inequality which
hinders fair and effective competition. Trying to harmonise supervision on a global basis
may avoid discrimination between EU and non-EU reinsurers. Restriction in the EU that
hinders reinsurers in their business relative to non-EU reinsurers may ultimately result in
adverse pricing differences which subsequently impact adversely on the EU reinsurance
industry.

EU harmonised market

Such regulation may introduce in Europe restrictions not previously thought to be
necessary, which is contrary to the freedom of establishment and the freedom to provide
cross-border services within the EU, as guaranteed by treaties. Under European law, these
sort of restrictions have to be objectively justifiable in the public interest. Regulation may
hamper the supply of reinsurance capacity provoking a negative effect for insurance
policyholders, as insurance companies would provide less capacity as a consequence.




mk/nb/552                                                                                 110
Experience in regulated markets

The reinsurance industry argues that most reinsurance insolvencies have occurred in
regulated markets. There is no evidence that the financial collapse of a reinsurer would
pose any systemic threat to the insurance market, although it could have a real negative
effect for any particular insurance company.

Flight of capital

Regulation in Europe may encourage a flight of capital to more amenable jurisdictions,
such as Channel Islands or Barbados (off-shore markets), as companies will find ways
around regulation or even exploit it. Changing the supervisory system may create
opportunities for those who wish to escape from regulation which can lead to an
increased risk of default in the reinsurance market.

EU harmonisation versus global markets

Although there is an argument that regulation would enable the European authorities to
negotiate reciprocal agreements of mutual recognition with other countries, notably the
US, it seems unlikely that it would achieve such an objective, since American authorities
(for protectionist reasons) would certainly resist such an opening up of the reinsurance
market. The Reinsurance Association of America argues that the US reinsurance industry
cannot support any proposal that would permit non-US reinsurers to assume reinsurance
risks from US cedants on the basis of a single licence through mutual recognition while
US reinsurers continue to be constrained by a 50-state regulatory system. Mutual
recognition is not feasible until US reinsurers are permitted to do business in the US in a
manner that will maintain a level playing field with non-US reinsurers.

According to the OECD and the CEA, obstacles still exist in some countries such as
monopolies, compulsory cessions, supervisory restrictions, tax restrictions (e.g. USA with
a Federal excise tax in reinsurance), compulsory deposits by reinsurers (as in France or
USA) or administrative impediments.

A common system of supervision in Europe should take into account the systems existing
in other countries, especially Switzerland. Also, supervisory practice should be taken into
consideration. The existing bilateral agreements between the Swiss Confederation and the
EU could probably be updated by a demand for local application of the same elements to
Swiss reinsurance. A system with a “high” degree of supervision would be difficult to
implement in Switzerland and other reinsurance markets.

Knowledge

Another difficulty in implementing reinsurance supervision arises from the limited
availability of reinsurance specialists. Given the small number of experts, according to
the Groupe Consultatif, it might be difficult for supervisory authorities to find appropriate
human resources. It may not be feasible or cost-effective to expect each local supervisor
to have the necessary skills to assess reinsurers’ security as well as their products.




mk/nb/552                                                                                111
      Harmonised supervision for the whole industry

      There is a network for reinsurance and direct insurance within all the EU market. If a
      supervision system is implemented it seems to be necessary to set up a uniform system
      for the industry as a whole, as the businesses of direct insurance and reinsurance are
      connected.

      Costs

      Regulation leads to on-going costs, direct and indirect. If regulatory authorities develop
      regulation with costs that outweigh their benefits, the market will become less efficient.
      Any regulation brings costs for the industry as a whole. Closer regulation increases the
      costs for the companies, arising from the additional time spent in preparing and providing
      information to the regulator.

      Implementing or enforcing regulation leads to higher costs for regulatory authorities
      which will need more resources and in particular for specialists in the reinsurance market.
      Due to the current situation in the reinsurance market, the reinsurer may not be able to
      recoup the increase in costs through higher premiums.

7.5   Impacts on the different approaches to supervision
      The extent of the impact of supervision will depend on the supervisory regime adopted
      and the extent to which it is more or less direct and detailed. A harmonisation of the
      system and of the requirements at an EU level is recommended by the majority of
      member states, whereby a model based on direct supervision is preferred.

      If it is decided to introduce harmonised supervision, some operators consider that direct
      and detailed supervision of reinsurance undertakings will not necessarily be the only
      solution and may have restrictive effects. In the large majority of cases, the prudential
      supervision currently exercised in the reinsurance undertaking’s head office country
      should suffice, whether exercised directly or not. Some argue that a stricter and closer
      supervision should be reserved for new players in the market. The Groupe Consultatif’s
      view is that, if reinsurance is supervised, this should not be at as detailed a level as direct
      insurance.

      The strength of the arguments for and against supervision presented above will depend on
      the level of supervision adopted. A more stringent level of supervision would increase the
      strength of the arguments.

      For example, a supervision equal to the supervision of direct insurers leads to mainly high
      security against insolvencies but creates a very high level of costs and market barriers for
      the reinsurers.

7.6   Cost-benefit analysis
      The arguments in favour of supervision need to be balanced against their cost. Closer
      supervision needs to be justified in terms of the value added for society. When there are
      alternatives for regulating an aspect, the most cost-effective regulatory practice should be
      the one which least impedes the ability of the market to respond to the consumer’s needs.




      mk/nb/552                                                                                  112
        Before undertaking important regulatory changes, the scale of the cost implications at all
        levels (supervised institutions, supervisory authority and possibly third parties) needs to
        be established and set against the anticipated benefits.

        Regulations will bring benefits where there is a probability that they will reduce market
        imperfections and failures or eliminate them. The extent of benefits is equal to the
        reduction in damages caused by market imperfection and failures. But regulation also
        gives rise to costs.

        The comparison of costs and benefits of regulation gives information about economic
        advantages. It has to be checked very carefully if the benefits of additional requirements
        of supervision are worth the costs of the impact on the reinsurance industry. Regulation
        should only be undertaken when the benefits outweigh the additional costs. An
        assessment of benefits should be oriented to regulatory objectives.

        Regulatory intervention is only likely to be justified if the nature of the market
        imperfection (if any) is causing a problem, if there are solutions for the imperfections to
        deliver a net improvement and if the regulation does not cause any other greater
        disadvantages.

        An analysis of the nature and degree of market failure should also involve an analysis of
        whether the benefits of regulation can ever exceed the costs. There are costs involved in
        pursuing regulation and, if pursued too far, the costs may come to exceed the benefits.
        Regulation can always be made more effective in terms of its defined objectives, but at
        the expense of higher costs. The aim is to balance the benefits of a higher degree of
        achievement of objectives against the costs.

        The view of the FSA (Financial Services Authority) in the UK is that some regulation can
        be counter-productive if, for instance, it erects unwarranted entry barriers, restricts
        competition in other ways, controls prices, stifles innovation, restricts diversification by
        financial firms, impedes market disciplines on financial firms, etc. For these reasons, the
        FSA recommends that all regulatory requirements should be subject to some form of cost-
        benefit discipline though, in practice, such exercises encounter formidable
        methodological problems.

7.6.1   Description of supervision cost-impacts
        The costs/benefits deriving from supervision can be classified into two categories: micro-
        economic which are more easily quantifiable and macro-economic which are not readily
        measurable.

7.6.1.1 Micro-economic impacts
        Costs directly related to the supervisory regime

        Designing, monitoring and enforcing regulations requires extra resources. These include
        administrative costs for the State, IT resources, human resources, training costs, control
        and supervision division costs and other administrative expenditures. This will be the case
        when no supervision already exists and a regulatory body has to be created. This situation
        will also occur when supervision already exists but must be extended into a new area
        which requires specialist knowledge of the reinsurance market.




        mk/nb/552                                                                               113
       In order to monitor the highly specialised market of reinsurance, a high level of training
       will be required in the supervisory organisation. Education of regulators will give rise to
       additional costs of supervision. Such costs are generally quite easy to measure as they
       consist of expenditure by regulatory bodies.

       The regulatory body could recover part of these costs and implement a fee charged to
       regulated companies. In practice costs for current supervision are mainly transferred to
       the supervised entities. In Germany, for instance, the industry pays about 90% of the
       supervisory costs. As implementation of reinsurance supervision is complex, the cost of
       its implementation are probably not recoverable. In turn these fees charged to reinsurers
       may lead to an increase of premiums.

       Costs of compliance

       The regulated reinsurance companies must use extra resources, including time, to comply
       with new regulations. These costs may include allocating the resources internally, costs of
       training, management time, authorisation costs, costs arising from disclosure. Generally
       these costs could have an impact on the final price to the consumer (policyholder).

       The use of extra resources can be significant. Global reinsurance companies estimate the
       cost being approximately four persons per year to comply with reporting obligations.

       The cost of harmonising supervision at an EU level will result in direct costs and costs of
       compliance that will be different for each country, as they depend on the extent to which
       regulatory practices already exist. These costs will also vary regarding the extent of the
       requirements required for harmonised supervision.

       Increase in premiums

       An increase in costs for reinsurers, directly or by a possible fee charged by the regulator,
       may lead to an increase in premiums for policyholders as explained previously. Costs of
       reinsurance to cedants would increase and as a result the cost of insurance to
       policyholders would increase too.

       At the moment the market situation of reinsurance companies would not permit an
       increase in premiums. In this case the costs have to be paid by the shareholders. The
       situation will possibly change in the future.

7.6.1.2 Macro-economic impacts
       Besides the micro-economic impacts on the economy as a whole, regulation may also
       bring indirect costs or indirect benefits which are generally hard to measure.

       Negative market impacts

       Negative market impacts include the costs of reduced competition arising from the loss
       associated with increased charges. Higher costs for reinsurers, brought by regulation, may
       reduce efficiency and lead to uncompetitiveness in the reinsurance market. The increase
       of costs for EU reinsurers could have a negative impact comparatively with non-EU
       reinsurers, and a consequence could be the flight to other countries as explained below.




       mk/nb/552                                                                               114
        Regulation may hamper the supply of reinsurance capacity producing a negative effect
        for insurance policyholders, as insurance companies will provide less capacity as a
        consequence.

        The demand in the reinsurance market can decrease as a result of regulation costs. These
        costs may have a repercussion on the cost of reinsurance and indirectly on the cost of
        insurance for policyholders.

        It is possible that the introduction of supervision would cause some companies to cease
        business, or that financial services would be transferred to less regulated areas. Indeed the
        enforcement of new regulations may create opportunities for those who wish to escape
        regulation (to amenable jurisdictions) which can lead to a weakening in the security of the
        reinsurance market. One possible impact would be the reduction in the choices of
        reinsurance products in the market. That situation also would mean higher costs which
        could also lead to a lack of competitiveness and job losses.

        Regulation can have also an impact on the availability of the products in the market, in
        case of licensing system in which unsuitable reinsurers are removed from the market.
        This may reduce a cedant’s scope for achieving an optimal allocation of capital.

        Regulation may also have a negative effect on small businesses. If regulation imposes
        high fixed costs, it may hinder new small businesses entering the market which could
        reduce competition.

7.6.2   Description of supervision benefit-impacts

7.6.2.1 Micro-economic impacts
        Reduction of costs

        Harmonised supervision can also lead to a reduction of costs at an EU level, as it would
        reduce the scope for duplication and eliminate the costs associated with different legal
        and regulatory regimes.

        Reinsurance companies doing business worldwide already have departments to serve the
        different supervisory regulations in different countries. This is highly cost intensive due
        to the existence of different disclosures required under different accounting principles.

        A single administration would avoid duplication of compliance costs arguably without
        any reduction in benefit.

7.6.2.2 Macro-economic impacts
        Positive market impacts

        Regulation can have a significant effect on competition. As explained in the first part of
        this section, harmonised regulation would permit free access to the competitive
        international reinsurance market and may lead to lower cost of reinsurance and indirectly
        of insurance. This situation could create a benefit for the policyholder by reducing
        premiums.




        mk/nb/552                                                                                115
Under a European passport system, regulation would enhance competition and create a
benefit by reducing the resources wasted competing for the market (e.g. high
commissions). The value of this benefit would equal the value of the reduction in
resources wasted, which in turn would equal the reduction in the costs of the firms
competing for the market.

Efficient competition also leads to a better and broader range of services. This means an
increase in quality that is brought about by regulation. Improved quality in the
reinsurance products leads to more secure products in the market. The benefit is to allow
insurers to select products more appropriate to their level of risk.

Confidence in the market, enhanced through regulation by setting minimum standard
requirements, leads to increased demand for reinsurance products which is beneficial to
the insurance industry as a whole (reinsurer, insurer, policyholder). As a general rule, an
increase in choice creates a benefit.

Regulation which removes firms guilty of misconduct from the market that would
otherwise contaminate the reputation of all firms in the market should increase overall
security. Reinsurance regulation implies more security for insurers which indirectly leads
to more security for policyholders. Greater security for insurers means less risk of failures
in the insurance market, although in the past there have been no significant cases where
an insolvency of a reinsurer did cause insolvency of direct insurer.

Finally, regulation that enhances market transparency for insurers due to a harmonised
level of quality of reinsurers leads to costs savings in the process of reinsurer selection.




mk/nb/552                                                                                116
8     Summary of reinsurance market practice for assessing
      risk and establishing technical provisions

8.1   Scope
      In accordance with the Terms of Reference, this chapter provides “ a summary of
      reinsurance market practice for assessing risk and establishing adequate technical
      provisions, the impact of securitisation and how reinsurers measure or take into account
      portfolio diversification in assessing their own capital requirements. Techniques for the
      calculation of probable maximum losses (PML) should be specifically addressed”.

8.2   Approach
      In reporting on the above objective, we undertook the following approach:

      §   Use of existing specialist knowledge;

      §   Use of questionnaires to KPMG offices and a number of interviews with reinsurers;

      §   Discussions with regulators and use of public information where necessary, to
          supplement information gathered from local offices;

      §   Reviews of existing published sources.

8.3   Market practice for assessing risk
      The risks for reinsurance companies are set out in chapter 3 of this report. The range of
      risks is diverse. Moreover, the amount of information available to the reinsurer depends
      on the cedant and will vary considerably, for example according to the segment of
      business, and the territory, as well as the individual cedant. Specific comments on foreign
      currency risk are included below, and reserving risk is covered in section 8.4. The
      assessment of other risks is highly dependant on the individual reinsurer.

      Soundly managed reinsurers will undertake exposure analysis as part of their assessment
      of underwriting risk. Individual records of contracts written will capture the underlying
      exposures, sum insured limits, etc. Overall risk assessment depends on modelling based
      on this. Different reinsurers extend this to different degrees of depth. We describe below
      a modelling approach which attempts to model all aspects of the reinsurers risks across
      the whole enterprise. This description is comprehensive and some parts of the overall
      process are adopted in isolation by some companies.

      Reinsurance companies face several categories of risks doing their business. The different
      risks are similar to those of direct insurers. The underwriting risk as an essential risk
      differs especially because the business written by a reinsurer is derivative. Usually, the
      spread of the business written by a reinsurer is much wider in terms of geography and
      type or line of business than that written by a direct insurer. This has a significant
      influence on the calculation of underwriting risk. The reinsurance industry deals with
      these higher risks by a diversification of its portfolio and pooling of individual risks.




      mk/nb/552                                                                               117
        For better risk management the reinsurance industry is working on internal risk models,
        especially relating to underwriting risk.

        Underwriting risk is the key risk for reinsurers. There are several other risks facing
        reinsurance companies. These risks are discussed in chapter 3. The risks considered to be
        the most significant after underwriting risk are:

        § credit risk

        § investment risk

        § currency exchange risk

        The reserve risk is part of the underwriting risk but is so significant that reinsurers
        consider it separately. There are risk management strategies established to handle the
        above mentioned risks. As the complexity of interdependencies and the interrelations
        between these risks differ significantly the risk management strategies differ for each risk.

8.4     Establishing adequate technical provisions
8.4.1   General comments
        Today most reinsurance companies use actuarial methods to assess the adequacy of
        reported reserves. Generally the reserves reported by the cedant are taken into the books
        of the reinsurer. The reinsurer receives claims reserves from all over the world and has to
        judge the quality of these reserves. Reserving quality is very different from country to
        country. For example, reported reserves on business written in the US tend to be very
        low. German business used to be reserved strongly at least in some lines of business (such
        as motor in the past) and has ultimately produced significant run-off profits.

        Incurred but not reported (IBNR) claims in proportional business are, in principle, set up
        in accordance with the amounts reported by the cedant. In some cases the
        IBNRprovisions set up by the cedants are not included in the accounts of the reinsurer or
        they are not sufficient, e.g. in third party liability. This is common practice for non-
        proportional business. In these cases and in the case of differing accounting policies
        between countries it is important that the reinsurer does its own analysis of IBNR claims.
        IBNR claims reserves can only be assessed using statistical methods which are discussed
        for the reported claims reserve generally in the following sections. These methods are
        applied to both proportional and non-proportional business although assumptions in non-
        proportional business are much more uncertain because of the higher volatility of non-
        proportional business and respective historical data.

        The actuarial calculation of the reserves in life and non-life business mainly addresses
        three major subjects

                -   adequacy of the reserves set up in the published accounts;

                -   adequacy of premium calculation;

                -   adequacy of the retrocession program.

        For this analysis actuaries apply different tools.




        mk/nb/552                                                                                118
        Life actuaries tend to model or remodel the premium and reserve calculation of the
        cedants by applying (modified) assumptions received by the cedant or derived from their
        market databases. The accuracy of the results of the life actuaries mainly depend on the
        underlying assumptions. In life business significant uncertainties remain in those cases
        where either not enough data is available from the cedant or other sources or where no
        data records are available due to the missing history of new products (for example in
        current processes of privatisation of health insurance).

        Non-life actuaries generally use triangulation methods for their work. In these models, the
        available data is divided into accident years and the related run-off years. If the earliest
        reliable accident year is not settled, it is necessary to set a so called tail factor to take the
        remaining run-off into account. Various kinds of models are used. Most of the models
        focus on the prognosis of the development factors that have to be used for the different
        development years. For these prognoses it is necessary to have as much homogeneous
        data as possible and, therefore, the underlying data is segmented. Large claims and
        cumulative claims are eliminated for a separate estimation. The quality of the non-life
        actuaries work heavily depends on the volatility of the development factors of the
        respective segment. The more homogeneous the underlying database is, the more reliable
        are the results of the actuarial analysis and vice versa. Because of the underlying business
        (i.e. environmental liability, US liability or catastrophe risks) there is a probability of
        significant uncertainties. The methods of reserve analysis for non-life business are
        discussed in the following section.

        Overall it can be stated that a well organized and well diversified reinsurance company is
        able to monitor its reserve risks properly.

        The impact of the reserve risks on the underwriting risks are obvious. Therefore this kind
        of analysis plays a significant part in the calculation of the underwriting risk of a
        reinsurance company. More details on that are discussed below.

8.4.2   Actuarial reserve analysis for non-life business
        Actuarial reserve analysis can be regarded as a three step process: definition and
        obtaining of the required data, segmentation of the business, analysis of the segments.

8.4.2.1 Required Data
        Defining and obtaining the required data is the most crucial step for a reinsurance
        company.

        For reinsurance companies it is difficult to obtain the data needed for the analysis. As
        mentioned in section 2.5.4. there is usually a delay in reporting claims. Another reason
        for the difficulties is that, depending on the complexity of reinsurance contract terms,
        cedants may want to evade a high effort of supplying the data or need more time to do so.
        In addition, a cedant may be interested in delaying the supply of data until the renewal of
        reinsurance contracts with advantageous contract terms. The problems of obtaining the
        required data from cedants could somewhat diminish in the future with the improvement
        of data systems. Systems which allow estimations of unearned premiums and claims
        provisions with an acceptable extent of reliability in an environment of constant delays in
        claims reporting do not exist yet and are currently being developed in practice.




        mk/nb/552                                                                                    119
For proportional business the figures are usually available on an accident year basis but
there is no information on single claims. Even this information is not visible from the
cedant’s account. For non-proportional business it is even more difficult to obtain the
requested data, especially for the layers written by the reinsurer. The historical data can
only be taken as significant if the structure of the written layers is comparable over the
years. Otherwise, claims information has to be adjusted for projection purposes. Data is
only available for the gross business of the reinsurer. To calculate deficiencies with an
impact on equity the calculation has to be done on a net business. The retro data is even
more difficult to get, because generally the retro cover is not based on single treaties or
segments of the incoming business, but is for example segmented differently or based on
whole accounts for a line of business.

For the analysis of gross business payments, outstandings, earned premiums and
commissions (brokerage) are essential. Usually the number of losses is taken into account
but generally these numbers are not completely available to the reinsurer. To calculate an
average loss size on the existing base would leave the analysed segments too small for a
statistical analysis.

The claims data may be available in accident year or underwriting year cohorts depending
on the type of business and the practices of the individual cedant. For each cohort, the
claims for each development period need to be available.

Companies often book their losses on an underwriting year (UY) basis. Underwriting
years may have a different duration which would distort the homogeneous behaviour of a
segment. Moreover, if an insurance contract with a period of e.g. five years is part of a
reinsurance treaty on underwriting year basis, any loss that is incurred in the second treaty
year would be allocated to the second development year and therefore regarded as an
IBNR loss which is not the case in strict terms. The problem with multiyear reinsurance
contracts on an underwriting year basis is that it is simply not known for losses incurred
in years following the underwriting year to what extent they are caused by increased
claims expenses (corresponding to a run-off loss on an accident year basis), IBNR or
claims incurred in years following the underwriting year. This makes an adequate
analysis of data difficult.

Because of such difficulties, the split by accident year if available is in many ways
preferable for analysis purposes.

Often the split by accident year is not available, and analysis has to be done on an
underwriting year basis, or this may be necessary as the market has always been
organised on an underwriting year basis (e.g. Lloyd’s and many other London Market
insurers and reinsurers).

For the analysis the actuary only takes business into account that has a bearing on the loss
development. Clean cut business is not analysed using triangulation projection
techniques.

Run off treaties should be available with their total history. If parts of the history of run-
off treaties are not available there should be a separate analysis.




mk/nb/552                                                                                  120
        If at the date of the actuarial analysis the current calendar year is not totally reported,
        reinsurance actuaries may leave out the last diagonal and correct the total reserves which
        are the result of their analysis by the payments booked for the current calendar year.
        Alternatively, the current calendar year can be extended to a full year by pro-rata grossing
        up or, better, using monthly or quarterly development factors. For the estimation of the
        current year’s reserve the Expected Loss Method may be utilised.

8.4.2.2 Segmentation of the Business
        The analysed business has to be sub-divided. The aim is to get segments with a
        homogeneous development of the run-off. The segmentation has to leave a statistically
        usable group of claims for the analysis. As mentioned before, cumulative events like
        catastrophes and other special features have to be eliminated in advance.

        Basically, the segmentation of the reinsurance business should be three-dimensional: line
        of business (LOB), type of reinsurance, region.

        The different lines of business have to be divided into at least long-tail and short-tail
        business. It is very important that any liability business is kept separate. This is difficult
        for motor business because generally reinsurance does not divide motor liability and other
        damages. For statistical reasons lines of business may be accumulated for the analysis –
        for example the complete property business might be analysed as one LOB.

        Within a LOB the business should be segmented by three types of reinsurance:
        proportional, non proportional and facultative business. Geographical segments have to
        be defined as well. Reinsurance business can be very different according to the region
        where it is written. The regional split can only be made according to the region where the
        business is written and data recorded. This does not necessarily mean that this segment
        only includes risks of this region.

8.4.2.3 Analysis of the Segments
        The first step in an analysis is the definition of the data to be used. If all necessary data is
        available the analysis can be run based on payments or on incurred amounts (including
        reserves). Incurred amounts may be influenced by the cedants’ accounting policy on
        reserves, but contains more information in the outstanding claims and reflects legal and
        other changes which may not work their way through to payments for some years. Thus,
        both the payments basis and the incurred basis should be considered.

        For non proportional business an analysis based on payments is often not possible since
        the payments for these contracts begin in later development years. For those cases the use
        of the incurred values is necessary.

        For the evaluation of the required reserves several actuarial methods are available, e.g.:

        § Chain Ladder Method

        § Bornhuetter-Ferguson Method

        § Cape Cod Method

        § Additive or Loss Ratio Step-by-Step Method




       mk/nb/552                                                                                    121
§ Expected Loss or Naïve Loss Ratio Method

§ Berquist-Sherman Method

§ Benktander Method or Iterated Bornhuetter Ferguson Method

§ Separation Methods

§ Fisher-Lange Method

§ Salzmann Methods

Variations of the above methods are also available. Some methods require data which is
usually not available to reinsurance companies.

The standard techniques applied by reinsurance actuaries are Chain Ladder (with
variations), Cape Cod, Bornhuetter-Ferguson, Additive Method and Expected Loss
Method. Detailed descriptions of the methods used are included in Appendix 4. 36

The methods used most commonly in practice are based on a triangle of loss data. The
only exception is the Expected Loss Method which only requires an estimation of the
ultimate loss ratio.

These methods require homogeneous segments. Since large losses or catastrophe losses
would distort the homogeneous development, they have to be treated separately. Ideally,
the complete development of such losses should be taken out of the triangles. A minimum
requirement is to avoid applying the year-to-ultimate factors to those losses but to review
their case reserve separately.

Which method will be chosen for a certain segment will depend on the actuarial analysis
of the available data. For example, if there has been a clear trend in claims development
in the past years, a Chain Ladder method would be appropriate. If there is a correlation
between loss development and premiums, Cape Cod could be the appropriate method.
Whatever method will be chosen, nobody can say for sure that it is in fact the correct one.

All methods require significant judgment in order to select the result to be adopted from
the different methods, with the key issues being:

§ The company’s philosophy regarding the degree of prudence will affect the
  provisions. There is no generally accepted level of prudence in the industry. The
  degree of judgement may be more or less limited by accounting principles. For
  example, if accounting rules require the use of best estimates, a provision is set up to
  the extent that the probability that claims will be greater than estimated is the same as
  the probability that they will be less than estimated.




36
     Examples of the Chain Ladder, Cape Cod, Bornhuetter-Ferguson and Separation method are
     contained in Swiss Re (2000) Late claim reserves in reinsurance, (Zurich).




mk/nb/552                                                                                 122
      § Particular judgement has to be applied to the loss ratio adopted for the recent years
        which is blended in as part of the reserves in the Bornhuetter Ferguson method and
        forms the reserve for the loss ratio method. If this loss ratio is provided by
        underwriters there may be undue optimism about the business performance, and the
        loss reserving specialist must understand and if necessary challenge the loss ratio
        being included.

      § The tail on long term business is particularly important and if the business category
        has not been written that long then there will not be adequate data and curve fitting or
        judgment must be applied.

      § The degree to which large losses are regarded as exceptional and removed from the
        data is also important. If too readily removed, there may not be sufficient allowance
        for future large loss emergence.

      § New market issues have to be understood and the effect on the development data
        available allowed for in the projection process.

      It is also relevant to note that for some classes development statistics in triangulation
      format are not appropriate. Examples of this are asbestos claims development; pollution
      claims development; health hazard claims development, and “spiral business” where
      business had been retroceded several times in the market. Also for complex pieces of
      business, specific modelling of the workings of the underlying business contracts is
      necessary. In all of these categories traditional methods are not applicable and are not
      likely to produce sensible results. The approach must be specifically tailored to the
      circumstances driving the loss development.

      The degree to which different reinsurers model specific situations separately from the
      balance of the account varies considerably. Best practice is for the reinsurer to understand
      the loss development in their account sufficiently to be able to identify contracts or types
      of claim which should be analysed separately. Smaller reinsurers are less likely to have
      the resources or sophistication to do this to the same degree as larger reinsurers.

      The ability to set adequate reserves is influenced by the degree to which actuarial analysis
      is undertaken, the independence of the loss reserving function from the underwriting and
      the degree to which the management takes a prudent stance on reserving issues. It is
      possible to consider past run-off to see if there is a pattern of setting reserves which had a
      favourable run-off, or whether the converse applies. Also it is possible to project future
      cash flows, and future loss emergence, and to monitor actual emergence against that
      anticipated.

8.5   Management of underwriting risks
      Underwriting risk is the fundamental risk of the reinsurer. The risk that the actual costs of
      claims will exceed the premiums earned is determined by several factors, which makes
      the management of underwriting risk very complex. The management starts with the
      analysis of the profitability of every single contract and ends with the capacity of the
      whole company limited by the amount of equity. In practice management of underwriting
      risk is organized for segments of business via several steps that are connected. The
      following steps are taken:




      mk/nb/552                                                                                 123
        §   for the business units the maximum amounts of liability with respect to premium that
            should be accepted are determined;

        §   underwriting guidelines are issued;

        §   checks are installed by third parties or computer systems that ensure that the
            underwriting guidelines are followed;

        §   retrocessions are defined that cover the incoming risk so that the retention rate is
            adequate in relation to the companies capacity.

        Whilst the principles are basically the same the precise steps differ significantly from
        company to company.

        Underwriting guidelines include the business segments and contract types that are
        permitted or not permitted to be written, respective minimum premium rates, the
        maximum risk exposure allowed (e.g. per segment, risk or treaty), maximum amounts
        allowed to be written by one or several underwriters and criteria to assess if and to what
        extent retrocession coverage is necessary. Usually, underwriting guidelines exist for
        business segments, which are quite detailed, but still leave a certain range of discretion to
        the underwriter. The process of preparation of underwriting guidelines is described in the
        following sections. Underwriting guidelines are prepared by one department of the
        reinsurer, e.g. the controlling department, approved by the board of directors and usually
        revised annually. Most importantly it has to be assured that they are being consistently
        applied in practice.

8.5.1   Fixing of capacities and premium rates
        The underwriting requires an allocation of the capacity in advance of a renewal season.
        The company has to determine what degree of risk it is willing to take. For the calculation
        the existing portfolio and the renewal has to be taken into account.

        The capacity is determined by the total amount of net equity available in the company or
        group. The net equity has to be allocated to the existing portfolio and to the different
        segments in order to come up with the maximum risk that the individual business units
        may write without jeopardizing the solvency of the company or group as a whole.

        To achieve this the company has to analyse the amount of risk borne by writing different
        kinds of contracts in different kinds of segments or regions. The amount of equity
        required depends on the risks included in the different products as well as on the
        retrocession purchased.

        These analyses lead to the process of fixing of capacities and the amount of net equity
        that the company is willing to risk within the individual selling units.

        The result of the analysis is documented in the underwriting guidelines and is mandatory
        for underwriters. If the individual underwriter or the business unit want to exceed these
        guidelines explicit permission has to be granted.

        In practice the process described above is applied by different methods. The methods
        used by the companies to derive their capacity and to allocate it differ significantly.




        mk/nb/552                                                                                124
Basically one can distinguish between a ratio approach and a risk modelling approach.

Ratio approach

A well known ratio approach which is similar to the methods used in the industry is the
Standard & Poor’s model. The model is applied in the assessment of the financial strength
of a company. The financial strength is measured in the long run by the ability to avoid
insolvency. So the major aim of the Standard & Poor’s rating is to identify capital risk
that can lead to insolvencies by using the complete net equity of the company.

The Standard & Poor’s approach defines the four major risks. There are risk factors
calculated by using ratios on a defined basis. The major risks are the underwriting risk,
the reserve risk, the credit risk and the investment risk. The basis for these ratios is easy
to calculate from the balance sheet of the company. They are:

major risk                                         basis

- underwriting risk                                - premium

- reserve risk                                     - book value per segment

- credit risk                                      - receivables

- investment risk                                  - book value per risk category

Also, reinsurance companies define ratios similar to the Standard & Poor’s approach
based on criteria like booked premium or liability taken. The concrete ratios are
developed by historical analysis based on the segments extrapolated to the future. For
high risk products like natural perils separate analysis is performed. The quality of this
approach is as good as the factors that are applied. In particular, the historical analysis has
to be done on special segments which have to be as homogeneous as possible. To achieve
this, all events that are not of a regular statistical relevance (like cumulative claims
events, catastrophes, and so on) have to be eliminated and analysed separately. There are
often difficulties caused by data quality especially for the older data. The analysis of
business needs to be done over the long term to see a significant development.

Risk modelling approach

A total enterprise risk model develops the risk categories discussed in chapter 3 of this
study like underwriting, credit, investment and reserving taking into consideration their
interactions.

A relatively new approach is the stochastic method for the analysis of risks based on
segments or the total account like for example capital at risk or optimising the
retrocession program. However, stochastic methods are not yet frequently applied by
reinsurers.

The allocation of capacities based on the calculation of a risk portfolio that uses a
probabilistic approach modelling different business segments diverges from the ratio
approach used by the rating agencies.




mk/nb/552                                                                                  125
        The most advanced models developed and employed by the leading reinsurance groups
        model underwriting risks using stochastic approaches and analysing the impact of special
        events (for example: a crash at the stock exchanges) using scenario techniques.

        In practice this has to be done at group level rather than at entity level.

        To handle the complexity of the problem total risk models are designed to derive
        distributions of losses taking into consideration the influence of different portfolio mixes
        and different retrocession programs.

        In due course, these approaches will become widespread. At present only the big market
        players are able to do these calculations.

        The currently used methods for the analysis of underwriting risk are comparable. A
        discussion of total enterprise risk models is included in section 8.5.3.

        The other important requirement is the premium rate that has to be paid by the cedant.
        The rates are usually derived from pricing models. These are actuarial models, based on
        reasonable assumptions on loss ratios which derive the premium level required. The
        parameters used for these analysis are either also developed from historical data of the
        company based on internal data basis or are drawn from external sources taking into
        consideration the results of the own reserve analyses.

        For the pricing of facultative business the parameters may be specific to the risk exposure
        of the risk insured and reflect its probable maximum loss. The probability of a major loss
        is also taken into account.

        In practice, it may happen that the underwriter gives discounts on the calculated
        premiums. There is a control issue on the extent to which these premiums are agreed
        when entering into the contract. If there are these agreements, the discount has to be taken
        into account for the risk calculation.

8.5.2   Organization of risk management
        The requirements concerning capacity allocation and premium calculation have to be
        applied to the individual business units. It is essential for the company to control this
        process.

        It is best practice to have separate organizational units which

        -       perform the pricing and capital allocation (capacities)

        -       do the underwriting

        -       control the observation of the requirements

        If there is no separation of the different departments, this may cause additional business
        risk. In practice, this separation of execution and control is not always in place.

        It should also be noted that depending on the reinsurance cycle the priced rates often
        cannot be achieved. A good risk management should reflect this when updating the
        underwriting guidelines.




        mk/nb/552                                                                                126
        Another major risk management factor relates to the information gathered from the
        cedant. The reinsurer has to rely on the information gathered by the cedant. There are
        other general sources of information which can be used, but the input on how much risk
        has been assumed by the portfolio has to come from the cedant. Especially for non-
        proportional business, portfolio information about the cedants portfolio gives no complete
        indication of the development of the reinsurance portfolio.

        History has proved that a lack of information on the reinsurer’s side about the cedant, its
        products, its risk strategy and its economic environment can lead to disastrous losses.
        This risk is greatest for business written through intermediaries.

        Accordingly, the underwriting guidelines have to define the degree of information to be
        gathered and the procedures to be taken before accepting businesses from direct insurers
        especially in the case of business accepted via intermediaries.

        One method of ensuring compliance with underwriting guidelines is to require that two
        underwriters have to sign a contract. However, this is of less practical use, because it is
        industry practice for the written documentation of a contract to be completed a month
        after entering into a contract.

8.5.3   Risk management across the whole enterprise
        This section describes a common approach to risk management across the whole
        enterprise. As most of the companies use a similar approach, the basic principles will be
        illustrated.

        There are differences concerning the approach over one or more periods. Some models
        automatically allow for investment risk. The techniques for deriving results differ from
        company to company.

        The model includes all lines of business, (possibly macroeconomic variables) and
        quantifies the variability of investment returns. It is based on an adjusted capital approach
        which allows the user to allocate the capacity of a company or group. It gives a complete
        overview of the risk portfolio of a reinsurance company.

        Claims are segmented into basic losses, large, single and catastrophe losses. Basic losses
        are assumed to follow a normal distribution. Large, single and catastrophe (cumulative)
        claims are simulated by the estimation of the expected amounts and the frequency. The
        amounts mostly follow a Pareto distribution while their frequency is generally
        represented by a Poisson distribution.

        There are alternative approaches where the probability distribution is determined by
        reference to special classes of frequency distributions without a division into different
        categories of claims. There is no information available on how these classes are designed.

        The risk based capital can be derived from the probabilistic distribution of risks and
        allows for an assessment of capital adequacy.

        In summary, the most advanced models developed and employed by the leading
        reinsurance groups model underwriting risks using stochastic approaches and analyse the
        impact of special events (for example: a stock market crash) using scenario techniques.




        mk/nb/552                                                                                127
In practice, the modelling has to be done at group level rather than entity level.

General implications

The aim of all the models is to identify a figure that quantifies the company’s overall risk
and enables the company to assess the adequacy of its capital or to allocate the available
capital.

The risk portfolio of a reinsurance company is a very complex dynamic system. It is
composed of underlying risk-driving factors, including events that may threaten the
business, as well as portfolios of insurance and financial market products or combinations
of both. The risk factors are by nature outside the company’s control, but can be managed
by portfolio techniques. Risk factors subject to portfolio management are time dependent.
For simplicity the models generally take a time horizon of between one and a few years
into account. In reality the time scale goes from an hourly basis for investment portfolios
up to the basis of decades for mortality rates.

The effect of fluctuating risk factors is generally measured in terms of changes in capital
and in the annual result.

The structure can be determined via identification of the various risk factors and a
combination of similar products in portfolios.

The risk portfolio is structured in line with the information required by management. In
particular, key factors concerning different lines of business, types of contracts or
geographical segments are taken into account.

Risk factors

The first step is the identification of the risk factors. It is necessary to distinguish between
economic and underwriting-specific risk factors. Economic risk factors comprise
macroeconomic variables such as fluctuating interest rates, foreign exchange rates,
inflation, gross domestic product growth or equity indices. Risk factors relating to
underwriting are large and cumulative claims like natural perils (earthquakes,
windstorms, floods) or man made threats such as fire in a large industrial plant, which can
result in business interruption. Other risk factors are, for example, changes in the legal
environment which can have a huge impact on liability claims (e.g. asbestosis). The
possible losses caused by underwriting specific risk factors usually have a major impact
on the portfolio but the probability of those events is relatively low. Due to this low
frequency and high severity aspect, these events are analysed as loss scenarios when
specifying underwriting risk factors.

Events with high frequency and low severity are excluded from the loss scenarios. The
impact of these claims is referred to as normalised business fluctuations which is assumed
to be a normal distribution. It is modelled directly at portfolio level by estimating yearly
aggregate loss or result distributions.

Finally, for each segment the claims ratio is split into categories of claims, for example,
basic claims, large claims, single claims and catastrophes.




mk/nb/552                                                                                   128
Risk factors trigger claims or influence the size of claims on many different contracts and
they influence the diversification of portfolios. For each possible event cumulative claims
may impact on many contracts.

The modelling of risk factors concerning underwriting loss scenarios has to be based on
expert knowledge and experience. Some loss scenarios can be based on events which
actually occurred in the past, allowing the company to fall back on past experience like
natural perils or liability threats (asbestosis). Other scenarios may not yet have been
experienced but they represent situations which could occur in the future.

The identified risk factors have to be quantified. For many underwriting specific risk
factors it is sufficient to specify a single distribution for frequency (per year), strength or
severity. It is assumed that these events can be regarded as independent and that the
underlying probability distributions do not change over time. For example, windstorms in
different years can be assumed to be independent of each other and their frequency and
strength are more or less constant. In the case of loss scenarios for which observations
were made in the past, analyses can be made of the losses incurred in the insurance
market as a whole. Physical models can also be used to assess loss scenarios associated
with natural perils.

Loss scenarios are, in practice, often described by frequency and severity distributions.
Severity distributions contain information about a specific portfolio or line of business so
that the generic concept of a risk factor is abandoned. On the basis of common underlying
risk factors there is only the possibility of an approximate calculation of dependencies
between losses on different portfolios.

Examples of underwriting loss scenarios are in property business arising from natural
perils such as earthquakes, floods, windstorms.

For third party liability losses there are no well established models as in the case of
natural perils. Quite often in practice it is necessary to rely on foresight and intuition.
Changes in people's attitudes and in legislation can have a significant impact. Examples
of third party liability losses include environmental pollution, asbestosis or product
liability.

Even lines of business that seem little exposed to risk, such as the motor business, require
closer examination. Events such as hail may cause significant losses on a motor portfolio.

Life and health loss scenarios include infectious diseases, such as Aids. Further examples
which have a more local influence include pollution or nuclear contamination, and
various natural perils, such as earthquakes or storms. Also, changes in the long term
trends of mortality and morbidity rates have an impact on loss scenarios. For example, the
trend of changing compensation payments to long-term care claims influences
significantly the development of a scenario. These potential losses are likely to have a
more long-term impact and are therefore more significant for long-term business.

In addition to the calculation described above there are also macroeconomic risk factors
that have to be taken into account. There can be factors which influence the business as a
whole for the company such as recession, domestic product growth or inflation.




mk/nb/552                                                                                  129
For long term business like third party liability or life and health management of interest
rate exposure of the portfolio has a strong impact on profitability. The interest-rate risk
can be limited by adopting a duration matching strategy.

For life business there is in practice a widespread use of asset liability matching to reduce
the long-term portfolios‘ sensitivity to interest rates. In contrast, property-casualty
business is less exposed to interest rate fluctuations given the long-term nature of their
liabilities. Here a matching strategy is generally not common.

The global nature of reinsurance business means that the market is exposed to the risk of
fluctuating foreign exchange rates which have to be modelled too. By and large foreign
exchange exposures can be reduced to a low level. Adequate reserves for claims
payments are held in each currency.

Investment risk is another risk factor which has an impact on the capital adequacy of
financial institutions in general. We refer to our analysis in section 8.7 of this study.
Credit risk also has to be taken into account. This is the possibility of a counterparty not
being able to meet its financial obligations. The loss potential is assessed by quantifying
the underlying exposure and the default probabilities of counterparties. The whole
contractual period must be considered and recoveries taken into account.

There is a trend towards increasing exposure to credit risk in view of the growing number
of new financial and alternative risk transfer products that encompass explicit or implicit
credit risk (see section 8.6).

Probability distribution

For the determination of a probability distribution for the yearly result the identified risk
factors are combined with the exposures and normalised business fluctuations have to be
quantified and added. The calculation is done either for the existing portfolio or for the
portfolio the company anticipates will be written.

The portfolio associated with high frequency events usually has a small claim fluctuation.
The normalized fluctuations are generally described by aggregate distribution done
yearly. Usually the distributions are based on the historical frequency and severity of
losses in the portfolio. The historical data used in this procedure should first be adjusted
for trends in claims inflation and changes in the underlying exposure. The claims data has
to be filtered for claims associated with the loss scenarios, to avoid double counting.

The identified results have to be aggregated. The probability distribution for the whole
exposure has to be constructed to account for all the different risk factors on the portfolio
and to show an overall result for the company.

To account for the interdependencies between different sub-portfolios, it is necessary to
start with the individual risk factors and their impact on the results of each portfolio. The
process is repeated for all risk factors in order to arrive at the overall result. With the
inclusion of retrocession into the model, the final result is derived either from net
underwriting results or from a separate analysis of the retrocession cash flows.




mk/nb/552                                                                                130
Risk capital

After the probabilistic model of the company’s risk portfolio is calculated, the results can
be compared with the level of risk capital. There is no standardised formula for risk based
capital. The underlying methods and assumptions have to be taken into account so that
the management can understand the applicability of the model to the company and its
limitations. Only then will the company be in a position to judge whether the underlying
assumptions correspond to their aims and if the scenarios used to model the risk portfolio
are adequate.

Once a company has selected a model for calculating the risk adjusted capital and fixed a
certain survival probability, it can determine the required level of risk adjusted capital. If
the risk-bearing capital exceeds the required level of risk adjusted capital, there is scope
for taking on additional risk by changing the risk portfolio. If the risk-bearing capital is
lower than the required level of risk adjusted capital, risk can be reduced by either
implementing measures on the investment side or by modifying underwriting exposure by
means of reinsurance or retrocession.

The information obtained from a probabilistic description of the risk portfolio can be used
for purposes other than the control of capital adequacy. For example, pricing can be
combined with the model described above. The actuarial pricing of reinsurance cover is
usually based on the principle of the premium being equal to the sum of the risk
premiums plus a loading. This calculation includes the net present value of liabilities e.g.
expected future cash flows discounted with an appropriate rate. A loading principle can
serve as a benchmark for the underwriter to allow a comparison of market conditions with
a targeted return. After inclusion of investment income and potential losses, the
distribution gives an indication of the probability of insolvency for a given portfolio and
retrocession programme.

Limitations

The major limitations of these models result from the following factors:

-       the determination of the different probability distributions is to a certain extent
        subject to judgement

-       the distribution parameters are gathered from historical data and there is a risk
        that future events will not resemble the past

Because the functionality of adjustable features ( profit sharing ) cannot be modelled, the
model does not fully reflect reality.

The argument against this criticism is that this represents an additional prudence factor.

In summary, it can be concluded that even such models do not represent the real world. It
is often necessary to work with planned portfolios. At present there are no better
approaches available at the corporate level.




mk/nb/552                                                                                     131
8.6   Monitoring credit risk
      Credit risk (excluding credit risk of investments) mainly relates to the collectability of
      receivables. Credit risk or counterparty risk (sometimes referred to as default risk) arises
      when the counterparty of a creditor fails to fulfil his contractual obligations. In general,
      all types of lending entails default risk.

      For assumed business this mainly belongs to premium income, for ceded business to the
      recoverability of loss reserves. The issue of reinsurance recoverables remains a
      significant one for the reinsurance industry and is focused on the ultimate collectability of
      retroceded liabilities.

      The use of retrocession creates a significant level of credit risk if amounts due under a
      retrocession contract are not fully collectible in case of insolvency. The monitoring of
      credit risk is important when placing retrocession cover.

      For international businesses, even if it is not common, sometimes bonds or stocks are
      deposited to secure technical reserves. Therefore, not all recoverables are at material risk,
      as companies may have used these techniques to substantially reduce the financial risk
      associated with future recoveries.

      However, the risk strategy of reinsurance companies depends on the market expertise of
      their underwriters supplemented by ratings of international rating agencies to make
      informed judgements about the good standing of the trading partners.

      Appropriate counterparties should be selected to diversify and limit credit risk, taking into
      account the importance of qualitative aspects such as the skill of management, market
      behaviour and long-term relationships, as well as their strengths and their ability to pay.

      Reinsurers should maintain an active dialogue with their partners and continually monitor
      their financial conditions so that the security that was originally anticipated will be
      realised at collection.

      The use of ratings by international rating agencies should complete the analysis of
      reinsurance companies to evaluate security. Ratings not only take into consideration other
      areas of analysis, such as operating performance and business position, but also benefit
      from the insight and judgement of experienced analysts. A rating is an indicator of a
      company’s ability to meet its financial obligations.

      Proper credit risk analysis performed throughout the industry leads to an efficient
      distribution of capital funds on competitive terms. In the absence of credit risk analysis,
      the credit risk still exists but can only be estimated. This risk is then charged back to the
      company through higher reinsurance fees. Credit analysis done by competing reinsurers
      drives down costs by reducing the uncertainty.

      Reinsurers with a high degree of directly written business tend to have enough market
      knowledge to evaluate the solvency of their customers, whereas reinsurers which write
      business through intermediates often have a more limited overview and have to rely on
      other sources of information. There is a high risk that the failure of an intermediary could
      result in bad debts.




      mk/nb/552                                                                                 132
      Naturally, credit risk increases with the duration of the reinsurance contracts, such as
      annuity reinsurance and the run-off of losses.

      As already explained, credit risk is the risk of a counterparty not being able to meet its
      financial obligations. There is a trend towards increasing exposure to credit risk in view
      of the growing number of new financial and alternative risk transfer products that
      encompass explicit or implicit credit risk.

      The loss potential is assessed by quantifying the underlying exposure and the default
      probabilities of counterparties. The whole contractual period must be considered and
      recoveries taken into account. The default probabilities are closely linked to retrocession-
      driving factors and are assessed per category of creditworthiness. A feature of credit and
      surety business is that periods of large losses typically persist for several years, with the
      result that the different underwriting years are not independent. Furthermore, it is difficult
      to hold well-diversified credit risk portfolios in a single economy given their strong
      dependence on macroeconomic variables.

8.7   Management of investment risks
      Generally the management of investment risk for reinsurance companies gives rise to the
      same considerations as for other financial institutions and therefore, general approaches
      to the management of investment risk are not discussed here.

      However, there are several aspects which are specific to the reinsurance industry:

      § Because of the international nature of underwriting, in practice the investment
        portfolio covers many currencies. These multi-currency investments bear special kinds
        of risks.

      § The reinsurance exposure has a potentially higher degree of volatility of the cash
        flows than the direct insurance. The volatility arises from the variety of different types
        of contracts (e.g. proportional, non proportional, facultative business) and the different
        types of business caused by the geographical spread of the exposure.

      § The premium calculation regularly takes into account investment income on funds
        supporting outstanding losses. Therefore, the reinsurance company depends on
        investment income (cash flow underwriting).

      Sometimes there is even an investment income guaranteed to cedants.

      These aspects indicate the need for sophisticated investment management. As a result of
      this, the market has started to develop asset liability management techniques. Our review
      of the industry revealed that the application of highly sophisticated multi-year simulation
      models is the exception rather than the norm. In practice, approaches such as duration
      matching are frequently used.

      Almost all companies frequently apply stress tests. Generally, there are systems in place
      that calculate the impact of defined changes in indices or interest rates. This area is dealt
      with in more detail in the “Study into the methodologies to assess the overall financial
      position of an insurance undertaking from the perspective of prudential supervision”.




      mk/nb/552                                                                                 133
      Taking only the underwriting risk into account, the investment strategy is, in general,
      rather conservative. Exceptions are some investments in compound instruments and
      derivatives. For example in Germany by the end of 1999, on average 47% of total
      investments of professional reinsurers were investments in affiliated undertakings, 24% in
      fixed income securities and loans, 18% in investment funds and only 3% in shares and
      other variable-yield securities.

      This means that the inherent risk of reinsurance business is regarded as being high.
      Therefore, management strategy is generally to avoid a risky investment strategy. The
      management of the company becomes difficult if assets are subject to a significant risk
      which is independent of underwriting.

      As the volatility in underwriting business is high, the modelling of an appropriate
      sophisticated asset-liability-management-system is quite complicated. Given the high
      degree of uncertainty, the confidence that can be placed in these models is limited. On the
      other hand, the efforts to implement such systems are significant. The reason is the
      complexity of the portfolio structure of a reinsurance company.

      The cash outflow of a reinsurance company, even in short tail business, tends to take two
      or three years. This is longer than in other industries. Therefore, even for short tail
      business, investment returns have to be taken into account.

8.8   Management of foreign currency risks
      As reinsurance is an international business, most of the reinsurance companies are
      exposed to adverse currency exchange movements.

      Most reinsurers write business in a large number of currencies. Therefore, the liabilities
      as a result of the international risk portfolio are paid in several different currencies.
      Although this kind of risk may have different aspects, the industry generally invests in
      relevant currency assets to match the equivalent currency liabilities.

      Companies enter into hedging transactions to reduce risks that can adversely affect their
      financial position and net income, including risks associated with changes in foreign
      exchange rates.

      A hedging instrument is defined as an asset or liability whose value moves inversely, and
      with a high degree of correlation, to changes in the value of the item being hedged.
      Various financial instruments can be used to implement hedging strategies to reduce
      foreign exchange risk.

      The industry practice of matching liabilities with the assets in the corresponding currency
      cannot cover the complete risk as generally investors are not able to manage perfect
      hedges as the timing and severity of the liabilities are subject to estimation.

      Two issues need to be addressed:

      § how can liabilities be hedged?

      § what is the amount of liabilities at the year-end and in the course of the year?




      mk/nb/552                                                                               134
How can liabilities be hedged?

Hedging instruments are intended to reduce risks resulting from changes in foreign
currency exchange rates. However, the hedging instruments themselves generate specific
risks. Risks associated with hedging instruments include correlation risk, basis risk, credit
risk and opportunity cost.

Correlation risk is the risk that the gain on the hedge position will not offset the loss on
the hedged item to the extent anticipated because the hedge and the hedged item did not
move in tandem.

Basis risk is the risk that the difference between the spot price of the hedged item and the
price of the hedging instrument will increase or decrease over time. The basis is
sometimes referred to as the spread. Many factors can influence the pricing of hedging
instruments and the underlying items being hedged.

Credit risk is the risk that the counterparty to the transaction will not honour its
commitments. The creditworthiness of the other party is particularly important when
dealing in instruments not traded on a securities or commodities exchange.

A commonly used technique of hedging is to match foreign liabilities directly with
investments in the same currency to eliminate the risks described above.

As long as these investments are not subject to market value risks, this form of hedging is
sufficient.

Unfortunately, this method of hedging may be suboptimal in terms of investment income.
Investments in bonds nominated in other currencies may earn higher interest. Shares have
in the past consistently achieved higher returns than bonds.

In addition a complete management of the liabilities in the books of a reinsurance
company could involve the handling of over 50 foreign currencies giving rise to
substantial administration costs.

Furthermore, hedging of liabilities generated from underwriting may not fit in with the
investment strategy of the company. In particular, the investment of the operational cash
flow in liquid investments may be inconsistent with a company’s investment priorities,
for example when a company is interested in the foundation of a major subsidiary which
has to be financed.

Therefore, in practice, as well as matching investments in the same currency as the
liability, hedging is practised by investing in a currency basket. Other methods are
investment in foreign currency options, future contracts or similar derivatives.

The use of a currency basket gives rise to the issue of the degree of correlation between
the basket of a few currencies and the development of the multi-currency portfolio.
Although analysis might show that this correlation has existed in the past this is not
necessary true for the future.




mk/nb/552                                                                                135
      Derivatives frequently do not match the payment pattern of the liabilities in regard to
      their duration. In particular either contracts with long duration are not available on the
      market or they are too expensive. Even if these derivatives are bought they do not
      guarantee full protection against adverse developments.

      What is the amount of liabilities at year-end and in the course of the year?

      With respect to this question several problems exist:

      §   What is the amount of liabilities to pay per currency and do the reported loss reserves
          represent this amount;

      §   How to deal with the time lag between the beginning of the contract and the reporting
          of the reserves by the ceding company.

      The effective amount of liability has to take into account whether the reported reserves
      are adequate. The reserves in that currency should not include significant margins or
      deficiencies.

      In practice, there are actuarial methods available which are capable of giving reasonable
      answers to the adequacy of loss reserves. In section 8.4 these approaches are discussed in
      detail.

      Although in many reinsurance companies actuaries are employed to work on loss
      reserving, they seldom do reserve analysis based on currency segments. As long as this is
      not done or impossible to do due to erratic developments within a currency defined
      segment, approximations have to be applied which result in additional uncertainties
      regarding the amount of liabilities in a certain currency.

      Another significant problem that may arise is the time lag between the signing of the
      contract and the reporting of loss reserves. In most countries loss reserves are reported
      just once a year. The reinsurance company has to estimate the loss reserves to overcome
      the information lag between the first cash flow at the beginning of the contract (e.g.
      premium payment) and the reserve reporting. The risk of misestimating significantly
      depends on the quality of the estimation system of the company and the general
      information available.

8.9   The role of securitisation
      Securitisation is used as a basic method for transferring insurance risk to the capital
      markets. This allows traditional risk-bearers such as insurance companies to be replaced
      by the capital market or investors. The capital markets can provide more capacity for
      risks than the reinsurance market especially for low frequency, high severity risks. These
      risks can otherwise be very difficult to insure.

      When traditional reinsurance capacity is insufficient or unavailable, securitisation is
      warranted, if the economic conditions are reasonable.




      mk/nb/552                                                                              136
8.9.1   Recent and future evolution
        In February 1994, reinsurance risks were securitised for the first time. Reinsurance
        markets nearly collapsed due to catastrophe losses in the previous years. Property
        catastrophe reinsurance was in very short supply in the wake of Hurricane Andrew and
        the Northridge earthquake in the early 1990s. The short supply, of course, led to inflated
        prices. All this led to the development of financial instruments capable of transferring
        insurance risk to the capital markets.

        More than USD 5 billion in property catastrophe risk has been securitised worldwide to
        date (about USD 1 billion annually). Securitisation has become established as an
        important tool for placing risk for insurers. However, securitisation has somewhat slowed
        in recent years. A possible reason for this could be the consolidation of capital markets in
        general. Although investments in securitised risks bear for the investor the advantages of
        over-average yields and a dispersion of investment risks, securitisation products remain
        complex and sometimes difficult to analyse.

        The future development of risk transfer through securitisations is being assessed
        differently within the industry. Some industry players primarily consider securitisation a
        form of advertising. This is certainly a positive effect that goes along with the initial
        offering of new and innovative products. Others believe that the volume of securitisation
        in the future will vary with the level of reinsurance prices and the development of capital
        markets. Still others contend that the role of securitisation will remain limited to
        catastrophe risks and not expand on traditional reinsurance as long as reinsurance rates
        remain stable and costs involved in securitisation remain high. The financing of new life
        insurance business, i.e. the financing of policy acquisition costs in life insurance through
        either bank loans or securitisation, is expected to gain importance.

        Undoubtedly, the relatively short experience with securitisation makes a forecast difficult.
        Swiss Re outlines in its study on capital market innovation 37 that key issues such as
        standardisation, regulation, and education still have to be resolved for an active
        securitisation market to develop. Swiss Re estimates the volume of annual catastrophe
        bonds to grow up to perhaps USD 10 billion by 2010 and sees a vast market potential for
        capital market solutions linked to non-catastrophe risks as well, although these will
        remain a complement for traditional reinsurance.


8.9.2   Aspects of securitisation
        Securitisation brings with it several advantages such as reduction of credit risk,
        diversification of funding for insurers and of investment for investors as well as a
        relatively high rate of return for investors, to name a few. Through securitisation, capital
        market participants have had the opportunity to become more familiar with the
        reinsurance concept.

        Securitisation has the quality of an AAA reinsurer and provides management with an
        unprecedented level of security. Underwriting risk could be transferred completely to the
        markets.


        37
             Swiss Re (2001) “Capital Market Innovation in the Insurance Industry” Sigma No. 3 (Zurich).




        mk/nb/552                                                                                     137
        Pricing and availability

        The search for coverage for larger amounts of reinsurance often proved unavailing or the
        coverage available was too expensive, since reinsurers limit their exposure to any one
        risk. Hence, securitisation can eventually be less expensive, with almost unlimited
        capacity making it a viable alternative. Securitisation provides in addition protection
        against fluctuations in the price of reinsurance through a multi-year coverage at set prices.

        Credit Risk

        Counterparty risk plays a significant role in the selection of reinsurers. During periods of
        financial stress, reinsurance becomes increasingly important. Diversified reinsurance
        sources and business relationships with financially strong reinsurers is paramount for
        insurers at such times. Instruments involving the capital markets can be structured to
        minimise credit risk.

        Insurance solutions involving the capital markets can be structured to minimise credit
        risk. Funds collected through the issuance of catastrophe bonds are invested in investment
        grade securities and held as collateral in a trust account for the benefit of investors and
        the reinsured. A non-US reinsurer commonly establishes a special purpose vehicle (SPV)
        as a trust account. This SPV then transforms the reinsurance risk into an investment
        security. The SPV matches every dollar in potential claims with a dollar of capital, giving
        this arrangement greater credit quality than conventional reinsurance.

        Higher rates of returns

        Catastrophe bonds tend to pay higher rates than those for corporate bond or asset-backed
        securities of the same credit rating. This spread or the difference between these rates
        typically compensates investors for model risk, when expected losses are higher then
        estimated, allowing for a cushion and the relative illiquidity of catastrophe bonds.

        Portfolio diversification

        Insurance linked securities reduce the overall statistical risk of an investment portfolio as
        insurance events are uncorrelated with fluctuations in the price of stocks and bonds.

8.9.3   Type of transactions
        A great amount of insurance securitisation transactions have involved catastrophe bonds,
        although long-tail risks could also be handled through this technique.

        Typically, a reinsurance contract between cedant and a SPV is entered into. The SPV in
        turn issues catastrophe bonds to investors. If there is no loss event, investors receive
        coupon payments on their investments and a return of principal. If there is a loss event,
        which is predefined, investors suffer a loss of interest and perhaps even principal as the
        funds are paid out to the cedant in fulfilment of the reinsurance contract.

        There are three types of triggers for the majority of catastrophe bonds, namely indemnity,
        index or physical. Settlement of the first type is based on actual insurer losses. This type
        has no basic risk, but there is the threat of adverse selection and moral hazard. This means
        the insurer tries to cede those risks that are most problematic or after reinsurance is
        purchased, the insurer is less motivated to mitigate the risks.




        mk/nb/552                                                                                138
        Settlement of index based securitisation is based on industry losses and could, therefore,
        expose an insurer to a material amount of basic risks. Lastly, a physical index is used in
        settling claims of the third type of securitisation.

        Although there have been a few securitisation transactions involving life insurance also,
        these transactions seem primarily motivated by the need for financing of new business in
        contrast to catastrophe bonds which primarily transfer risk.

8.9.4   Techniques of securitisation
        Insurance linked securities can be structured to minimise portfolio risk. As mentioned
        earlier, most insurance linked securities involve catastrophe bonds (short “cat bonds”).
        Returns stemming from cat bonds depend on the performance of an index of industry
        losses reported by an independent agency, for instance Property Claims Services.

        A typical transaction involves the investor, who purchases bonds from the issuer, in this
        case the SPV (special purpose vehicle), which in turn enters into an insurance contract
        with the cedant. Special purpose vehicles are usually licensed as reinsurers on an offshore
        location such as Bermuda or the Cayman Islands. Its sole purpose is the business related
        to the securitisation. Total focus on this one order of business works to minimise the risk
        to which the counterparties are exposed.

        Proceeds provided by or invested in the bonds end in a trust account, which purpose the
        SPV normally serves, with restrictions as to investment and withdrawal of the funds.
        These investment earnings together with premiums paid by the cedant serve as coupon
        payments to the investor. If there has been a loss event, the amount due to the cedant as
        the defined coverage is paid out to the cedant at the end of the “loss development period”
        following the maturity date, during which the amount of losses payable is determined. If
        there are no loss events, the principal amount along with final coupon payments is paid
        out to the investors.

        There are many variations to this model. For instance, often a reinsurer serves as an
        intermediary between the SPV and the cedant. The reinsurer can then retain some risk for
        himself before retroceding to the SPV. The amount retroceded could also be divided
        among two contracts, for example, allowing for recovery under the first based on index
        losses and the second based on actual losses of the cedant. Another variation would be a
        bond issue with a guarantee to return some percentage of principal to the investors at
        maturity if there is no loss. This feature is known as defeasance. If there is a loss a full
        return on principle can be paid out at a later date. This delayed repayment is then funded
        by zero coupon bonds, that are purchased at the maturity date with the guaranteed portion
        of the proceeds.

        There is an alternative to cat bonds for transferring risk, namely through swaps. Here a
        series of fixed payments is exchanged for a series of floating payments whose values are
        determined by the occurrence of an insured event. The counterparties of a swap must be
        insurers in some jurisdictions. But in New York, insurance regulators ruled in 1998 that
        insurance linked swaps, in which payments are not based on the actual loss of the cedant,
        are financial contracts, and it is questionable whether such contracts can be entered into
        by insurers and reinsurers.




        mk/nb/552                                                                               139
8.9.5   Techniques for the calculation of probable maximum losses (PML)
        Reinsurers assess PMLs on both a contract by contract basis and across segments. Overall
        loss scenarios are also considered by many reinsurers and can be thought of as a whole
        account probable maximum loss. However, the degree to which such assessments are
        made is very variable.

        The techniques for calculation depend on the type of reinsurance written. For facultative
        business, cedants should advise a PML based on an individual exposure assessment e.g.
        from an engineer’s report. The reinsurer needs to know the basis of this PML and ensure
        it is a probable maximum loss rather than possible maximum loss or estimated maximum
        loss. The reinsurer then assesses its PML by applying the underwriting limits, sum
        assured, etc.

        For per event insurance, the reinsurer needs to identify for each contract and each line of
        business the value and location of the exposures. A catastrophe model can then be used to
        assess the accumulated exposures and possible losses. All such assessments can be
        summarised in a database/spreadsheet. For pro-rata business, cedant’s PMLs should be
        used and pro-rated.

        Some reinsurers use PML factors e.g. an estimated percentage which is considered a
        possible loss is applied to the sum insured. All PMLs so assessed must be captured
        centrally. However most reinsurers would not be in a position to set up fully complete set
        of PMLs. Any individual reinsurer will be able to assess PMLs far more satisfactorily
        with some books of business than for others.

        Overall PMLs necessitate sophisticated modelling of the underlying exposures on which
        PMLs have been assessed as considered above. These must include consideration of
        disaster scenarios.

8.10    Financial condition reporting
        The nature of the business that reinsurers are exposed to is extremely diverse and is not
        suitable for standardisation of the approach to risk assessment and the establishing of
        technical provisions unless broken down to more standardised sub-segments. Even then
        most reinsurers will have exposure to non-standard books, and there is the issue of
        aggregation across different classes.

        This aggregation requires assessment of the dependence structures across the different
        risk factors. This is a difficult process usually involving significant uncertainty and
        requiring judgment as well as adequate analytical abilities to exist. Any standardised
        approach is likely to be difficult to carry through to this part of the process. However, true
        risk assessment and assessment of capital adequacy cannot be completed except at this
        final stage.




        mk/nb/552                                                                                 140
       Given this diversity good governance requires some centralised assessment of the issues
       within each reinsurer. This type of approach has been covered in section 8.5.3. Without
       such an approach a reinsurer will be more restricted in seeing how the various types of
       risk interact and affect the capital levels required. However some reinsures will not have
       the sophistication to develop these techniques in the short term and moreover there will
       often be issues such as lack of information from cedants which will restrict the ability to
       use this approach.

       In these circumstances it would still be possible for a suitable expert in a central position
       to assess the various issues faced by the company. Given that any rule bound form of
       regulation of reinsurers is faced with difficulties caused by the diversity of the business, it
       would appear that any such rules would be enhanced by an assessment by a suitable
       expert backed by a financial condition report. This would cover the approach to risk
       assessment and technical provisions, including comments on the retrocession program,
       dependencies between classes, and other wider issues affecting the company. A financial
       condition report should also cover risk accumulations, the effect of any securitisations
       written or placed, and other matters relevant to the assessment of capital adequacy.

       The availability of such a report would provide the regulator with the ability to
       understand the approach being taken and the quality of the work being undertaken. It
       would provide a significant amount of information that would not be available through
       standardised rule based regulatory approaches. Also, it would form a basis for discussions
       with companies.

8.11   Summary
       There is a very high degree of diversity of reinsurance business. The approaches to risk
       assessment and establishing technical provisions are therefore very wide. Practical
       constraints on the degree of sophistication which can be utilised are very real and not
       easily overcome due to the international exposures involved.

       Good practice involves a central function assessing the overall picture. A financial
       condition report which summarises the issues and the assessments made would be an
       excellent source for regulators to become aware of the controls and practices in place.




       mk/nb/552                                                                                  141
Appendix I

Description of certain reinsurance arrangements

Main types of reinsurance


Facultative business and treaty business

Reinsurance can be arranged between the insurer and the reinsurer, in respect of
individual risks or in respect of a group of risks. Facultative reinsurance relates to one
specific risk. Treaty reinsurance relates to a group of risks.

                                         Reinsurance




                          Facultative                      Treaty
                          Reinsurance contracts can be divided up into
                          two main groups; facultative arrangements
                          apply to one specified risk, treaty arrangements
                          apply to a group of risks

Under facultative business the reinsurer receives an offer from the insurance company to
underwrite a risk. The offer determines the nature of the risk, start and end of the
insurance period, the sum insured and the premium. The reinsurance company can accept
the risk offered by the ceding company in full or in part as a proportion or as a fixed sum.
This type of agreement is designed to cater for the following unusual factors.

§ size (personal accident cover),

§ type or conditions (chemical plants particularly prone to explosion),

§ likelihood of occurrence (such as the insurance of a satellite).

There is also a relatively unusual type of contract known as facultative obligatory cover.
Under this type of arrangement the cedant chooses which risks are to be ceded and the
reinsurer is obliged to accept them. This type of contract is not very common, but is
similar to treaty polices.

Under treaty reinsurance the cedant (the company taking out the reinsurance cover)
agrees to cede, and the reinsurer agrees to accept all business written by the cedant which
falls within the specific terms of the contract (the treaty) that they have entered into.
Individual risks are not negotiated.




mk/nb/552                                                                                142
Proportional and non-proportional business

Both, facultative and treaty contracts, may be concluded on a proportional or non-
proportional basis.
                                          Reinsurance


                         Facultative                        Treaty



Non-proportional             Proportional       Proportional         Non-proportional




                                  Quota-Share           Surplus           Excess of loss         Stop loss

Under proportional reinsurance the reinsurer agrees to cover a proportionate share of
the risks ceded. Premiums and losses will follow that of the ceding company. Loss
adjustment expenses, however, are not necessarily shared on the same basis.

Non-proportional cover allows the insurer to retain risks up to a certain predetermined
limit, whether on a risk by risk basis or in aggregate (risks are pooled to determine
whether or not the limit has been exceeded). Non-proportional reinsurance arrangements
play an important role in an insurer’s risk management. Arrangements of this nature, if
constructed carefully, can enhance an insurer’s results.

Proportional reinsurance arrangements dilute an insurer’s results by ceding an element of
premiums and claims. They make both profits and losses smaller. In this way,
proportional reinsurance increases an insurer’s capacity to accept risks. Proportional
arrangements cannot improve the loss ratio of an insurer’s net account compared to that
experienced on its gross account. Non-proportional reinsurance however can enhance the
results of its net account compared to the results of its gross account.

Proportional treaty reinsurance

Quota-Share

The quota share contract is the simplest of all forms of treaty reinsurance. The reinsurer
agrees to reinsure a fixed proportion of every risk accepted by the ceding company, and
so shares proportionately in all losses. In return, the reinsurer shares the same proportion
of all direct premiums (net of return premiums), less the agreed reinsurance commission.
The treaty will specify the class(es) of insurance covered; the geographical limits and any
other limits on restrictions (such as any specific types of risks or perils excluded from the
treaty). The treaty usually provides that the ceding company will automatically cede the
risk while the reinsurer will correspondingly accept the agreed share of every risk
underwritten that falls within the contract.

(Source: Carter, 2000)




mk/nb/552                                                                                  143
Surplus

Similar to “quota-share”, surplus treaty is a form of proportional reinsurance by which the
insurer accepts a certain share of risk, receiving an equivalent proportion of the gross
premium (less reinsurance commission) and paying the same proportion of all claims.

The basic difference between the two are that under surplus treaties the reinsured only
reinsures that portion of the risk that exceeds its own retention limit while under quota
share arrangement, there are no retention limits. Furthermore, quota share reinsurance can
be used for any class of insurance whereas surplus treaties can only operate for property
and those other classes of insurance where the insurer’s potential maximum liability is
categorically expressed.

(Source: Carter, 2000)

Non-proportional treaty reinsurance

Excess of loss reinsurance

Under a contract of excess of loss reinsurance, the reinsurer only becomes liable once a
claim exceeds the retention of the ceding company (the retention is also known as the
deductible). The treaty may set an upper limit on the reinsurer’s liability. These limits are
often referred to as excess points. Any further element of the claim is borne by the ceding
company, or may be covered by further layers of excess of loss reinsurance.

Stop Loss reinsurance

A stop loss treaty is a form of non-proportional reinsurance which limits the insurer’s loss
ratio, (the ratio of claims incurred to premium income). It may apply either to a particular
class of business or to the insurer’s total result. For example the reinsurer may be liable to
pay for claims once a loss ratio of 110% of net premium income is reached, upto a
maximum limit of a 150 % loss ratio. Should the loss ratio exceed 150% any further
losses are borne by the insurer.

Reciprocity Business

This is the reciprocal exchange of reinsurance business. Reinsurance companies might
seek an exchange of reinsurance business in return for their own cessions, particularly
when their own business is profitable. Reasons for reciprocity business can be the
company’s desire to obtain a more diversified business, to increase their net premium
income by adding to premiums retained from their direct business the premiums for
reinsurance business (Source: Carter/ Lucas/ Ralph: Reinsurance, 4th Ed., 2000).
Reciprocity business in these cases can be understood as traditional reinsurance business.
However, reciprocity business can also be understood as ART business if the reinsurance
assumes both profitable and unprofitable business from the same ceding company with
profits and losses offsetting each other.

Factors determining the risk profile of reinsurance contracts

The risk that the reinsurance company is exposed to when writing a reinsurance contract
depends, amongst others, upon the contractual features of the respective contract. The
following provisions can increase or decrease the risk:




mk/nb/552                                                                                 144
Sliding-Scale Commission Rate : by using sliding-scale commission rates the
reinsurance company can reward a ceding company for ceding profitable business and
conversely penalise a cedant for poor experience. This gives the ceding company an
incentive for underwriting (and ceding) high quality business.

Profit Commission: by paying a profit commission in addition to a flat commission the
reinsurance company can reward the ceding company for a better than average
experience. In the case of a poor experience the reinsurance company pays lower profit
commissions partly offsetting the higher loss payments.

Loss Participation Clauses: by using loss participation clauses the assuming company
can penalise the ceding company if a treaty’s loss experience deteriorates. Under these
provisions the reinsurer can recover expenses from the ceding company.

Profit sharing: under profit sharing agreements the insurance company returns at regular
intervals a varying percentage of the amount by which net premiums exceed claims.

Overall, the risk the reinsurer is exposed to depends on the overall reinsurance program of
the ceding company. For example a reinsurance company writing a quota-share contract
is exposed to a higher risk if the quota-share is not accompanied by an excess-of-loss
treaty (compared to a quota-share that is accompanied by an excess-of-loss).




mk/nb/552                                                                               145
Appendix II
(Source: Reinsurance, January 2000)

Captives by domicile –1998

The following data gives an overview of other important captive domiciles:

Domicile                                Official statistics

Non-US western hemisphere
Bermuda                                          1497
Cayman Islands                                    485
Barbados                                          215
British Virgin Islands                             80
Bahamas                                            23
British Columbia                                   16
Curacao                                            15
Subtotal                                         2331

Europe & Asia
Guernsey                                          360
Luxemburg                                         255
Isle of Man                                       175
Ireland                                           151
Singapore                                          51
Switzerland                                        23
Jersey                                             14
Gibraltar                                          10
Subtotal                                         1039

US onshore
Vermont                                           334
Hawaii                                             54
Georgia                                            15
Colorado                                           14
Tennessee                                           9
Illinois                                            8
US Virgin Islands                                   8
Delaware                                            6
New York                                            2
Maine                                               1
Rhode Island                                        1
Subtotal                                          452

Total                                            3822




mk/nb/552                                                                    146
Appendix III

Lloyd’s: summary of the regulatory approach

Anybody wishing to establish a new syndicate at Lloyd’s (whether intending to
underwrite insurance or those writing predominantly reinsurance) must obtain consent to
do so. The consent will be for:

§ the management of a specific syndicate (with effect from a specified date);

§ for specific years of account; and

§ to write specific classes of business (Risk Categories) – this will include writing
  reinsurance business.

Any Lloyd's consent to form and manage a new syndicate may be subject to conditions.

Applicants must produce Realistic Disaster Scenarios. These are designed to enable
syndicates, managing agents and Lloyd’s Regulatory Division to see a syndicate’s
potential exposure to major losses. They enable the syndicate to demonstrate that risk is
managed adequately. They also highlight to the syndicate where their major exposure is
and allow the Regulatory Division to see whether the necessary systems and controls
exist within the syndicate and there is adequate reporting at board level. Fifteen disaster
scenarios have been prescribed by Lloyd’s (e.g. European storm/flood with a £10 billion
insured loss, loss of a major North Sea oil/gas complex to include property damage,
removal of wreckage, liabilities, loss of production income and capping of well).

Lloyd's will test the assumptions in the business plan and application against realistic
ultimate loss ratios by class of business. Lloyd’s sets capital levels for the supporters of
the syndicate on the basis of these realistic assumptions and in conjunction with a risk
assessment which uses, inter alias, the Risk Based Capital (“RBC”) system.

In addition, a new syndicate will attract an additional loading calculated using various
factors from the business forecast and other conclusions drawn from the overall
application, and interviews with key staff including the compliance officer and the
proposed active underwriter. A syndicate loading will be added to the RBC figure for the
first three years of account for every new syndicate. This will be recalculated each year
based on updated information obtained from the agent

Monitoring

The regulatory focus at Lloyd’s is risk-based, as opposed to rule-based. Best practices and
benchmarks are established in conjunction with the leaders in the major lines of business,
not just among Lloyd’s syndicates but also among major companies.

All syndicates (insurers and reinsurers) have to publish an annual business plan. These
are provided to capital providers of each syndicate, and are monitored centrally by the
Regulatory Division of Lloyd’s. The plans must include information on:




mk/nb/552                                                                               147
§ Management and management control systems

§ Description of market conditions

§ Each class of business written

§ Reinsurance arrangements

§ Potential impact on the syndicate’s results of Realistic Disaster Scenarios

§ Aggregate monitoring

§ Forecast levels of business

In the past, Lloyd’s required independent loss reviews of any syndicate incurring losses in
any one year exceeding 100% of syndicate capacity, and the findings of the reviews were
used as a basis for strengthening regulatory practices in the market.

Although such reviews are no longer automatic, the major themes which emerged –
namely risk management practices, individual competence, and the LMX spiral underpin
the current regulatory approach. Lloyd’s monitoring efforts focus on perceived high risk
areas. Investigations are targeted on business plans, realistic disaster scenarios and peer
group comparisons. The aim is to highlight problems and encourage stronger risk
management.

As a result of investigations into the LMX spiral, Lloyd’s instituted a daily review of
underwriting slips: regulatory staff check slips for inherent risk, coding, pricing and
consistency with syndicate business plans. The review also considers large risks, and
those written 100% by individual syndicates. The Regulatory Division has also, in the
past, conducted reviews into the market-wide use of specific reinsurers, so as to identify
potential problems should the reinsurer collapse.

Lloyd’s also undertakes reviews of all managing agents and syndicates; these include
examination of underwriting slips and outward reinsurance cover notes, examination of
the practices used to establish the reinsurance to close, and those used to establish the
realistic disaster scenarios. On the basis of these reviews, agents and syndicates are
allocated a competency rating, which is then fed into the risk based capital system.

Capital requirements

Risk based capital is the term used to describe Lloyd's methodology for calculating
members' funds at Lloyd's. There are two main elements : the Risk-Based Capital formula
and where appropriate, a capital loading.

The formula looks at the historic experience of each category of business (including
reinsurance) and seeks to equalise the expected loss cost to the Central Fund of each
portfolio. This means that each underwriting portfolio should present the same risk in
terms of Lloyd’s chain of security. For existing members, the formula determines the
capital required to cover both underwriting in the proposed year and the possibility that
the reserves set for past years are insufficient. The formula largely assumes an average
level of credit for reinsurance but the actual reinsurance spend is currently being phased
in. Diversification credit is applied across years of account, for business mix and for




mk/nb/552                                                                               148
participating across several managing agents. Where a syndicate feels its performance is
better than market average it can apply to use its own data. Any resulting improvement in
the syndicate's ratio will feed through into those of its members.

In addition, a capital loading may be imposed if the monitoring work performed by the
Regulatory Division gives rise to concerns. All existing syndicates and agents have been
given a rating from 1 (least good) to 4 (best). Those causing concern i.e. ratings 1 or 2,
may be subject to a loading (currently 20% and 10% respectively).

The Risk Assessed Capital ("RAC") software uses the formula and, if applicable, any
loading to calculate an RAC ratio. If the calculated ratio is below the minimum (45%) the
minimum percentage will be applied to the member's capacity. This results in the Funds
at Lloyd's amount to be provided by that member. If the RAC ratio is above the minimum
then the RAC percentage figure is applied directly to the member's capacity to produce
the FAL amount.

New syndicate ratios are produced by using the RAC model and a Lloyd's adaptation of
the assessment undertaken by the FSA for new entrants to the insurance market. This
involves, inter alia, reviewing syndicate business plans for the first three years of trading
and calculating minimum capital requirements sufficient to cover at least that period. A
similar process is carried out in year 2, but this also takes into account the actual versus
planned situation for year 1. The new syndicate should submit an outline business plan
for the first three years of account. Specific regulatory requirements in respect of
reinsurance

Lloyd’s maintains good standards with regard to the financial security of reinsurers. As a
market, it is one of the world’s largest reinsurers. The proportion of reinsurance ceded
was 31.4% of gross premium income for the 1997 account. Inter–syndicate reinsurance
has fallen steadily and was £425 million in 1999.

There are no formal guidelines for excess of loss reinsurance arrangements although the
market has tended to be conservative in its use of unrated companies.

Financial strength ratings are widely used to as part of the decision to purchase
reinsurance. Lloyd’s Regulatory Division does, however, place limitations on quota share
arrangements. To be acceptable, quota shares must not exceed 20% of syndicate capacity
or 50% of premium in the particular risk category. Where the reinsurer is not a Lloyd’s
syndicate, it must have minimum net assets of at least £150 million, have a Standard &
Poor’s rating of A+ or better and/or a Best’s rating of A or better, and be incorporated in
one of a number of specified jurisdictions.

Lloyd’s has also introduced more general requirements for managing agents in the form
of the “Code for Managing Agents: Managing Underwriting Risk”, issued in 1997. It
sets out the agent’s general responsibility in respect of risk management and provides
guidance as to how this may be achieved. It includes sections on:

§ Determining the underwriting and reinsurance policy of the managed syndicate

§ Accepting risks on behalf of the syndicate

§ Managing the reinsurance programme




mk/nb/552                                                                                149
With regard to the management of the reinsurance programme, the code suggests that,
where practicable, a reinsurance security committee should be established to introduce
procedures for monitoring and assessing the security of, and exposure to, reinsurers on all
types of reinsurance. In particular, it should compile a list of acceptable security for all
types of reinsurance and, in respect of each reinsurer, should set appropriate maximum
exposures at class of business, syndicate and agency level. This will ensure that adequate
information is available to assess the syndicate's protections at any point in time.
Procedures should also be developed and implemented for obtaining the Board's authority
for purchasing reinsurance from reinsurers not currently on the list.

The reinsurance security committee will need to ensure that all individuals with authority
to purchase reinsurance are fully aware of the list of acceptable security for all types of
outward reinsurance and of any maximum exposure levels. It will also need to satisfy
itself that systems and procedures are in place to provide the necessary control framework
and management information to enable those responsible for reinsurance security to fulfil
their responsibilities.

Finally, the payment performance of reinsurers will need to be monitored, and any
disputes or failures of cover should be reported to the Board.




mk/nb/552                                                                               150
Appendix IV

Detailed description of actuarial reserving methods used

Triangulation

The used triangles have the following format:

            Development Year
   AY          1         2              3           …            n-2        n-1        n
    1        C(1,1)   C(1,2)          C(1,3)        …          C(1,n-2)   C(1,n-1)   C(1,n)
    2        C(2,1)   C(2,2)          C(2,3)        …          C(2,n-2)   C(2,n-1)
    3        C(3,1)   C(3,2)          C(3,3)        …          C(3,n-2)
   …          …         …              …

    n-1     C(n-1,1)   C(n-1,2)
     n       C(n,1)

where C(i,k) is the accumulated loss (either incurred or paid) for accident year i at
development year k.

Corresponding triangles can be constructed for the development of the premium or the
commission and brokerage.

A wide class of methods can be specified as loss development factor methods.

In the underlying model each (conditioned) expectation of an unknown amount C(i,k+1)
with k>n-i can be described as

             E[C(i,k+1)| C(i,1),…,C(i,k)] = E[C(i,k+1)| C(i,k)] = f(k) · C(i,k).


Chain Ladder Method

The best known method to estimate the unknown factor f(k) is the Chain Ladder Method.

Chain Ladder estimates f*(k) are weighted averages of the historical development factors,
i.e. the year-to-year factors f(i,k) = C(i,k+1)/C(i,k), k= n-i:

                                      n− k              n− k
                            f*(k) =   ∑ C (i, k + 1) / ∑ C (i, k ) .
                                      i =1              i =1


Applied to the diagonal elements of the triangle, a square will be obtained with the
ultimate position in the last column.




mk/nb/552                                                                                     151
This is the standard version of the Chain-Ladder-Method. For a proper actuarial analysis
several adjustments are required, e.g.

    -   a limitation of the scope of accident years
    -   a consideration of trends within the observed development factors f(1,k),…, f(n-
        k,k )
    -   a smoothing of Chain Ladder-factors f*(1),…, f*(n-1) in case of instable patterns
        via several functions (e.g. Exponential, Weibull, Power, Inverse Power)
    -   a tail factor f(tail) if the earliest reliable accident years are not settled

Adequate estimates of tail factors are either market factors or an extrapolation of the
smoothing function.

Ultimate premiums and ultimate commissions also have to be estimated.

Since the estimates for the ultimate loss are heavily dependant on the diagonal value
C(i,n-i+1), any outliers on the diagonal will show a remarkable effect. Some methods can
be applied to adjust the diagonal. The diagonal value is split into a developing part (which
the development factors are applied to) and a non-developing part, this part is added to
the other part.

A favourite method to calculate this split is the Cape-Cod-Method.

Using the so called year-to-ultimate factor

                               u(k) = f (k) · … · f (n-1) · f(tail)


– with f(·) being estimated with Chain Ladder or a smoothing or any other method – and
the lag factor

                                          l(k) = u(k) −1

the used premium l(i) · P(i) is computed (with P(i) being the ultimate premium for the
accident year i).

With the average diagonal loss ratio based on the used premium

                                   n                         n
                           CC =   ∑ C (i, n − i + 1) / ∑ l (i) ⋅P (i)
                                   i =1                    i =1


C(i,n-i+1) is split into a developing part


                                          CC · l(i) · P(i)

and a non-developing part (which may be negative)


                                 C(i,n-i+1) - CC · l(i) · P(i).




mk/nb/552                                                                               152
Inherent in this method is the assumption that premium rates are stable. If this is not the
case, the historical premiums need to be adjusted to take account of rate changes. Thus
for proportional business information about changes in the quota of the cedant have to be
available. For non-proportional business the cycle of the underlying rates needs to be
considered.

Bornhuetter-Ferguson Method

Another method commonly used in the United States is the Bornhuetter-Ferguson
Method.

Apart from the development factors described above this method depends on independent
expectations about the accident years. An initial loss ratio LR(i) for the accident /
underwriting year is required that may be the underwriters’ estimation. Also market
information or the average of the historical loss ratios, calculated with the Chain ladder-
ultimates, may be taken into account.

With the lag-factor l(i) and the ultimate premium P(i) the ultimate loss for year i is
estimated to be

                                   C(i,n-i+1) + l(i) · LR(i) · P(i).


Additive or Loss Ratio Step-by-Step Method

The Additive or Loss Ratio Step-by-Step Method is also a method sometimes used by non-
life actuaries.

With P(i) being the ultimate earned premium the development of the loss ratio LR(i,k) =
C(i,k)/P(i) is analysed instead of C(i,k) only.

In the underlying model each (conditioned) expectation of an unknown amount C(i,k+1)
with k>n-i can be described as

        E[LR(i,k+1)| LR(i,1),…, LR(i,k)] = E[LR(i,k+1)| LR(i,k)] = d(k) + LR(i,k),

and the unknown movement of the loss ratios d(k) is estimated by

                            n− k               n− k        n− k        n− k
                  d*(k) =   ∑ C (i, k + 1) / ∑ P(i) − ∑ C (i, k ) / ∑ P(i)
                            i =1                i =1       i =1        i =1


which can be interpreted being the weighted average rate of year-to-year movements of
the loss ratios.

Also this method takes trends, smoothing and a tail into consideration.

                (LR(i,n-i+1) + d*(n-i+1) + … + d*(n-1) + d*(tail)) · P(i)

will be the expected ultimate loss within this model.




mk/nb/552                                                                               153
Expected Loss Method or Naive Loss Ratio Method

For business without any historical development or for the current year being not fully
reported the Expected Loss Method or Naive Loss Ratio Method may be the appropriate
way to estimate the ultimate loss, which is calculated for the accident year i using

LR(i) · P(i).

The ultimate loss ratio LR(i) may be derived from the pricing process, underwriter’s
information or, in case of a given history and a current year being not fully reported, from
historical loss ratios.




mk/nb/552                                                                                154
   Appendix V

   Main Sources

§ Basel Committee for Banking Supervision: ISDA’s response to the Basel Committee on
  banking supervision’s consultation on the new capital accord, May 2001.

§ Brendon Young and Simon Ashby (2001) “Insurance As A Mitigant for Operational
  Risk”Operational Risk Research Forum, Vers.2, (May).

§ IAIS (2000) “On Solvency, Solvency Assessments and Actuarial Issues”, Issues Paper
  (March).

§ IAIS (1998) “Supervisory Standard on Derivatives” Supervisory Standard No. 3,
  (October)

§ National Association of Insurance Commissioners (2001) Securities Valuation Office
  Research Vol.1 , Issue 2, (February).

§ National Association of Insurance Commissioners (2000) Financial Regulation
  Standards and Accreditation Program, (December).

§ Insurance Steering Committee (2001) IASC Draft Statement of Principles, (December).

§ Tillinghast, Towers-Perrin (2000) European Commission ART Market Study, (October),
  London.

§ Babbel, D./ Santomero, A. (1996) “Risk Management by Insurers: An Analysis of the
  Process” Wharton Financial Institutions Center Research Papers, No. 96-16.

§ Reinsurance Association of America (1996) Alien Reinsurance in the U.S. Market.

§ Financial Stability Forum (2000) Report of the Working Group on Offshore Centres,
  (April).

§ Comitè Europèen des Assurances (2000) Framework for a European Regime for the
  Supervision of Cross-Border Reinsurance, (May).

§ Comitè Europèen des Assurances (1999): “Towards a single “passport” for reinsurance in
  Europe” CEA Position Papers, (May).

§ IAIS (1998) “Supervisory Standard on Licensing” Supervisory Standard No. 1, (October).

§ IAIS (2000) “Guidance Paper for Fit and Proper Principles and their Application”
  Guidance Paper No. 3, (October).

§ European Commission (2001) “Approaches to Reinsurance Supervision-Follow-up and
  Structure of Work Programme” Discussion Paper to the IC Reinsurance Subgroup,
  (June).




  mk/nb/552                                                                          155
§ European Commission (2001) “Considerations concerning “licensing” system and
  “passport” of reinsurance supervision” Discussion Note to the Members of the IC
  committee on Reinsurance, (June).

§ European Commission (2001) “Solvency II: Presentation of the Proposed Work” Note to
  the Solvency Subcommittee of the Insurance Committee, ( March).

§ European Commission (2000) “Approaches to Reinsurance Supervision” Discussion
  Paper to the IC Reinsurance Subgroup.

§ European Commission (2002) “Study into the methodologies to assess the overall
  financial position of an insurance undertaking from the perspective of prudential
  supervision” A study by KPMG (to be published April/May).



  OTHER REFERENCES



  1. Cologne Re (1998) Risk Insights, (September), Vol.2, No.4.

  2. Swiss Re (1996) Rethinking Risk Financing, (Zurich).

  3. Swiss Re (2001) “Capital Market Innovation in the Insurance Industry” Sigma No.3
     (Zurich).

  4. Swiss Re (2000) Late claim reserves in reinsurance, (Zurich).

  5. Lloyds (1998) “A Review by U.S. State Insurance Regulators” Report of the
     Examination Team to the Surplus Lines (E) Task Force, (September).

  6. Standard & Poor’s (2000) “The French reinsurance market 1999” Global
     Reinsurance Highlights, (September).

  7. Standard & Poor’s (1999) “Ten years in Reinsurance” Global Reinsurance
     Highlights, (December).

  8. Lloyd’s (2000) “Two top reinsurers team up to form web-based exchange”, Lloyd’s
     of London Press Limited, (December).

  9. Stefan Förster, Dr. Alexander König (1999) “Capital at Risk“ Fachreihe der
     Bayerischen Rück, (June), Issue 25.

  10. Eberhard Müller(2000) “Sinn und Unssinn von RBC-Modellen – Anmerkungen zur
      Nichtlinearität von Risiken“ Zeitschrift für Versicherungswesen, Nr.21/1, November.

  11. Swiss Re (1997) “New perspectives: Risk securitization and contingent capital
      solutions”, (Zurich).

  12. Standard & Poor’s (2000) Standard & Poor’s Response to Basel Committee
      Proposals, Standard & Poor’s CreditWire, London, (January).




  mk/nb/552                                                                           156
13. G. Blomberg und Dr. W. Schnabel (2000) “ Nicht-proportionale Rückversicherung in
    der Sachversicherung” Versicherungswirtschaft, Heft 21/2000.

14. Ernst Wehe (1994) “Rückversicherung im Umbruch Versicherungswirtschaft, Heft
    21/1994.

15. Andrea Heß (1998) “Financial Reinsurance” Hamburger Gesellschaft zur Förderung
    des Versicherungswesens mbH, Heft 20, (January).

16. Rolf Nebel (2001): The Case For Liberal Reinsurance Regulation, Geneva
    Association Etudes et Dossier No. 247.

17. Dr. Thomas Renggli (2000) “ART 2000 – Entwicklungstendenzen in der nicht-
    traditionellen Risikofinanzierung” Zeitschrift für Versicherungswesen, Nr.7/1,
    (April).

18. Hugh Rosenbaum (1998) “A Good time to hold an insurer captive” Reinsurance,
    (June), 17-19.

19. Tony Dowding (2000) “No holds barred” Reinsurance, (January), 14-15.

20. George Sandars (2000) “Growing appreciation of ART” Global Reinsurance, 64-67.

21. D. M. Jaffee and T. Russell (1997) “Catastrophe Insurance, Capital Markets, and
    Uninsurable Risks” The Journal of Risk and Insurance, Vol.64, No. 2, 203-230

22. Dr. Peter Liebwein (2000) “ Klassische Rückversicherung als Tailor-Made solution”
    Versicherungswirtschaft, Heft 17/2000.

23. Dr. M. Grandi and Dr. A.                Müller   (2000)   “Versicherungsderivate”
    Versicherungswirtschaft, Heft 9/2000.

24. Guy Carpenter (1998) “Global Reinsurance Analysis 1998” A Guy Carpenter Special
    Report, Guy Carpenter & Company Inc., (September).

25. Swiss Re (1998) “The global reinsurance market in the midst of consolidation”
    Sigman No.9/1998, (Zurich).

26. Moody’s Investors Service (1999) “Assessing Credit Risks of US Property and
    Casualty Insurers” Moody’s Rating Methodology, (March).

27. A.M. Best (2001) “Current Guide to Best’s Insurer Financial Strength Ratings” A.M.
    Best Ratings & Analysis, July.

28. Warren Cabral (1998) “Bermuda’s hidden treasure” Reinsurance, (February).

29. Janina Clark (1998) “Europe inside and out” Reinsurance, (September).

30. Marie-Louise Rossi (1998) “The world according to Europe” Reinsurance,
    (September).




mk/nb/552                                                                          157

				
DOCUMENT INFO
Shared By:
Categories:
Tags:
Stats:
views:19
posted:10/12/2011
language:English
pages:158