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
This report contains 157 pages
Appendices contain 16 pages
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
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:
Please also note that the Insurance Unit of the Commission has a website, where other
documents of interest can be found:
Brussels, January 2002
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”.
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
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.
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.
Reinsurance and reinsurers: relevant issues for establishing general supervisory principles, standards
and practices, February 2000
2 Similarities and differences between insurance, reinsurance
and other risk transfer methods
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”.
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.
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
Draft Statement of Principles (DSOP); Insurance Steering Committee, IASC, June 2001
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
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
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
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.
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
§ reinsurers can provide experience and expertise in new lines of business or new geographical
§ 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
The special case of financial reinsurance is described in section 126.96.36.199.
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.
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
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.
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
§ 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.
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
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
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
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.
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
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
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
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.
2.6 Other methods of risk transfer
Other methods of risk transfer include the following:
§ Securitisation of the risk
§ 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
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
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.
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
188.8.131.52 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
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
The Tillinghast report provides details of the special features of the regulatory aspects of
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.
3 Reinsurance and risk
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”.
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;
§ reviews of existing published sources.
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.
184.108.40.206 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
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
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)
Babbel, D. / Santomero, A.: Risk Management by Insurers: An Analysis of the Process, in: Wharton
Financial Institutions Center Research Papers, No. 96-16, 1996.
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
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.
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.
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.
220.127.116.11 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.
18.104.22.168 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
§ 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 .
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).
22.214.171.124 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.
126.96.36.199 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.
188.8.131.52 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.
184.108.40.206 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.
220.127.116.11 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
Other examples of insurance industry trends which have also affected the reinsurance industry
§ 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.
18.104.22.168 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
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).
Carter, R. / Lucas, L. / Ralph, N.: Reinsurance, 4th Ed., 2000 , p. 735
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
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
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,
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
Profit sharing Use of adjustable
premiums experience on
the respective insurance
Fluctuation in Class of business Pooling, retrocession
Credit Risk Cedant’s credit Payment patterns Monitoring of cedant,
Activities Risks Risk Factors triggering Mitigation Strategies
Reinsurance Underwriting Changes in risk Mortality/morbidity Diversification,
Life – factors experience, early retrocession
Erroneous Adverse selection by Quota share treaties
assumptions ceding company, retrocession
(esp. surplus accumulation of
Random War Exclusion
Random Contagious disease Pooling; retrocession
Investment Interest rate Bonus declaration Reinsurer uses investment
Risk risk, market details diversification strategies;
risk, credit risk Wide range of market matching assets and
Life – non- Underwriting Erroneous Class of insurance, Support by health
proportional assumptions market experience, examination
Changes in risk Mortality experience Diversification,
Random War Exclusion
Random Contagious disease Pooling, retrocession
Activities Risks Risk Factors triggering Mitigation Strategies
ART/Fin Re Credit Risk Cedant’s credit Payment patterns Monitoring of cedant
Investment Interest risks on
Other Risk Business not
admitted for tax
Investments Investment Fluctuation in Diversified investment
Risk equity prices, portfolio, asset-liability
fluctuation in matching
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
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
3.5.2 Proportional versus non-proportional contracts
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.
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
22.214.171.124 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.
126.96.36.199 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.
188.8.131.52 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
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
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.
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.
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.
4 Description of the global reinsurance market
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”.
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
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.
Noted by Standard & Poor’s in their Global Reinsurance Highlights 2000 edition
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
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.”
Source: As noted in Global Reinsurance, September 2000 “The French reinsurance market 1999”
Source: Global reinsurance – Dec 1999 “Ten years in Reinsurance”
“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
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).
Source: Baylis Mark, Global Reinsurance, appendix 4, pages 1-3
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
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
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%
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.
Source: Baylis, Mark, Global reinsurance, appendix 4, page 1-3
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
Regional breakdown of ceded non-life premiums 1997
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%
Zurich Re 2%
AXA Re 1%
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.
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%
Source: EU Commission, Report: Results of Questionnaire on the Supervision of Reinsurance
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
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
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.
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.
Reinsurance, October 2000
Bloomberg, L.P.: Munich Re, Swiss Re ; Accenture set up internet site, 18.12.2000
Lloyd’s of London Press Limited: Two top reinsurers team up to form web-based exchange,
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
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
§ 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
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.
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.
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 :
2. The Cayman Islands
7. The Isle of Man
(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.
The Role of offshore insurance, Jim Bannister Developments Limited 2000
Source: Tillinghast Towers-Perrin, Swiss Re Economic Research
The Role of offshore insurance, Jim Bannister Developments Limited 2000
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.
Global reinsurance – September 2000 “Look! They’ve killed reinsurance”
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.
Source: EU Commission, Discussion Paper to the IC reinsurance Subgroup “Approaches to
Reinsurance Supervision”, 2000
5 Description of the different types of supervision approaches
currently used in the EU as well as other major Non-EU
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”.
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.
Types of supervision can be classified in a number of ways. The IAIS identifies five main
(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
(iv) every reinsurer doing business with a domestic reinsurer is licensed;
(v) uniform licensing being extended with additional requirements for the insurer or the
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.
Reinsurance and reinsurers: Relevant issues for establishing general supervisory principles, standards
and practices, February 2000
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.
184.108.40.206 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
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.
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
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
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.
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
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
* domestic ü ü ü ü ü ü ü ü ü
*non-domestic X X ü X ü X X X X
* 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
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.
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
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.
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 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.
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
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
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.
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
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.
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
§ 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.
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
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.
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
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.
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
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.
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
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
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.
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
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.
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.
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.
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
§ 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
§ 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
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
§ 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;
§ 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
§ 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.
The regulator can challenge the valuation of an asset arising from an outwards
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
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
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.
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.
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.
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.
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.
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);
§ 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
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.
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.
Reinsurance is in most aspects regulated in the same way as direct insurance. Some
differences however exist, but not concerning solvency 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
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
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.
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.
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
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
220.127.116.11 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.
18.104.22.168 Regulations currently in place
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.
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.
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.
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 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
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
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
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
22.214.171.124 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).
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.
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.
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
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
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.
126.96.36.199 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
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.
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.
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.
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.
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
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.
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
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
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
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
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.
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
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
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
§ 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 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.
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
§ 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.
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
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
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.
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).
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.
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
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%
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.
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
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.
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.
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
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
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
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
6 The rationale with regard to supervisory parameters
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,
- 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
- 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
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
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
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
Limited supervision involves the application of only some elements of the direct
insurance supervisory system to reinsurers.
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
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
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
Such an approach requires extra resources to enforce the rules which means the
supervisory costs are higher than under a system of indirect supervision.
Reinsurance and reinsurers: Relevant issues for establishing general supervisory principles,
standard and practices, February 2000
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
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”.
6.4.2 Classification of parameters 22
188.8.131.52 Parameters relating to direct supervision
The principal parameters relating to direct supervision, grouped by the IAIS insurance
core principles, are as follows:
- 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;
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.
§ market conduct;
§ financial reporting;
§ on-site inspection:
- inspection by the supervisor;
- inspection by third parties, such as auditors.
184.108.40.206 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
220.127.116.11 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
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.
ibid paragraph 21
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.
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
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
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
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
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.
18.104.22.168 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
- directors, in the case of a locally incorporated reinsurer;
- senior management;
- the approved auditor;
- 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
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.
IAIS Fit and Proper Principles
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
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’
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.
22.214.171.124 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.
Reinsurance and reinsurers: Relevant issues for establishing general supervisory principles,
standards and practices, February 2000
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 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.
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
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.
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
§ 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
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:
These areas are based on the IAIS’s Core Principles Methodology approved in October 2000.
§ 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
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 Credit risk
ü Investment risk
ü Globalised risk portfolio
ü Currency risk
ü Timing risk
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
126.96.36.199 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.
188.8.131.52 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
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.
184.108.40.206 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
§ 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.
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
220.127.116.11 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
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.
18.104.22.168 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
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.
22.214.171.124 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
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.
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.
126.96.36.199 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.
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
188.8.131.52 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
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
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
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.
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
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.
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.
184.108.40.206 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
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.
220.127.116.11 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.
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
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;
§ 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.
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
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
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
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
18.104.22.168 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.
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.
22.214.171.124 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
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.
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
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
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 .
Reinsurance and reinsurers: Relevant issues for establishing general supervisory principles,
standard and practices, February 2000
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.
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
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
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.
Consultative Paper “A New Capital Adequacy Framework”
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
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’
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
Reinsurance Association of America, Alien Reinsurance in the U.S. Market 1996 Data
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
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
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.
Principles of Reinsurance, Insurance Institute of America, p.201
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
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 .
Best’s Key Rating Guide, Life and Health Edition
Standard & Poor’s Property/Casualty Insurance Ratings Criteria
Moody’s Rating Methodology Assessing Credit Risks of US Property and Casualty Insurers
Fitch Non-Life Insurance Ratings Criteria
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
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.
7 The arguments for and against reinsurance supervision
and a broad cost-benefit analysis
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”.
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 .
Financial Stability Forum, Report of the Working Group on Offshore Centres, April 2000,
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
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.
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.
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.
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
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
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.
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 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
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
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.
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.
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.
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
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
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
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.
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
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
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
126.96.36.199 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.
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.
188.8.131.52 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.
Regulation may hamper the supply of reinsurance capacity producing a negative effect
for insurance policyholders, as insurance companies will provide less capacity as a
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
7.6.2 Description of supervision benefit-impacts
184.108.40.206 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.
220.127.116.11 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
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.
8 Summary of reinsurance market practice for assessing
risk and establishing technical provisions
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”.
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.
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.
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.
18.104.22.168 Required Data
Defining and obtaining the required data is the most crucial step for a reinsurance
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.
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
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
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.
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.
22.214.171.124 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.
126.96.36.199 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
§ 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.
Examples of the Chain Ladder, Cape Cod, Bornhuetter-Ferguson and Separation method are
contained in Swiss Re (2000) Late claim reserves in reinsurance, (Zurich).
§ 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
§ 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
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:
§ 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
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.
Basically one can distinguish between a ratio approach and a risk modelling 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
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
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.
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
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
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
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.
In practice, the modelling has to be done at group level rather than entity level.
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
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.
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.
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
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.
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).
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.
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
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
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.
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
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.
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
§ 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”.
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
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?
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
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.
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
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
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
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.
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
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
Swiss Re (2001) “Capital Market Innovation in the Insurance Industry” Sigma No. 3 (Zurich).
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.
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.
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.
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.
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
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
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
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
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.
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 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.
Proportional and non-proportional business
Both, facultative and treaty contracts, may be concluded on a proportional or non-
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
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)
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
(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.
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:
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).
(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
Cayman Islands 485
British Virgin Islands 80
British Columbia 16
Europe & Asia
Isle of Man 175
US Virgin Islands 8
New York 2
Rhode Island 1
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
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
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:
§ 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
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.
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
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
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
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
Finally, the payment performance of reinsurers will need to be monitored, and any
disputes or failures of cover should be reported to the Board.
Detailed description of actuarial reserving methods used
The used triangles have the following format:
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)
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.
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-
- 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
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
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).
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
Another method commonly used in the United States is the Bornhuetter-Ferguson
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-
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.
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.
§ 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
§ IAIS (1998) “Supervisory Standard on Derivatives” Supervisory Standard No. 3,
§ 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),
§ 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,
§ 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,
§ 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).
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