1 Financial reinsurance, as an alternative to traditional reinsurance, is increasingly gaining significance as a component in insurance companies' approach to total risk management. The use of financial reinsurance, which represents a combination of risk transfer and risk financing, could add value to an insurer's risk management programme by providing flexibility and liquidity.
2 The purpose of the Notice is to provide a framework that will facilitate the development of financial reinsurance, ensure clarity and consistency in accounting treatment and provide users of financial statements with adequate information to assess the financial positions of insurers.
3 This Notice sets out the Authority's stance on the use of financial reinsurance, the definition of financial reinsurance, the application of risk transfer rules and accounting treatment as well as disclosure requirements.
Authority's Stance on Financial Reinsurance Transactions
4 Registered insurers (direct insurers, reinsurers and captive insurers) can enter into financial reinsurance transactions in respect of general business. Direct general insurers, however, are required to inform their Board of Directors of any such transactions. They are advised to use financial reinsurance arrangements that involve elements of risk transfer.
Definition of Financial Reinsurance
5 Due to the diversity of financial reinsurance products, sometimes referred to as "finite risk reinsurance", it is difficult to have a prescriptive definition for financial reinsurance. In general, it may be distinguished by some or all of the following characteristics:
-
multi-year contract term except for cases that follow the expiry of original policies;
-
retrospective rating provisions that give the contract parties future rights and obligations as a result of past events; where premiums, commissions or commutation agreements depend, or depend in part, on the timing and amount of claims payments;
-
premiums are set taking into account the future (expected) investment income;
-
the financial outcome of the contracts, including the effect on the profit of both parties, can be predicted with some certainty at the outset, that is, variability of outcome is reduced; and
-
combined coverage for asset (investment) risks and liability (insurance) risks.
Risk Transfer Rules and Accounting Treatment
6 Financial reinsurance contracts entered into by an insurer shall be accounted for in its quarterly and annual returns, according to their economic substance in accordance with generally accepted accounting principles.
Risk Transfer Rules
7 To determine the substance of the transaction, it is necessary to assess whether there has been a significant transfer of insurance risk between the ceding insurer and the assuming insurer. Insurance risk may comprise either or both of underwriting risk (i.e. the uncertainty as to the occurrence of the loss event and amount of claim payments) or timing risk (i.e. the uncertainty as to when claim payments will be made). A significant transfer of insurance risk is deemed to have taken place under a contract of reinsurance when the following conditions are met:
-
it is reasonably possible that the assuming insurer may realize a significant loss from the contract; and
-
it is reasonably possible to have a significant range of outcomes under the contract.
"Significant" should be assessed in the context of the commercial substance of the contract or contracts being evaluated as a whole, and should be judged with reference to the range of outcomes that would reasonably be expected to occur in practice.
8 The assessment as to whether insurance risk is transferred should be made prospectively, at the time the contract is entered into. The method of accounting should be followed consistently over the whole period of the contract. If there has been a material change in contract terms during the period of the contract, the insurer should perform a new assessment of whether or not a significant transfer of insurance risk has occurred.
Accounting Treatment
9 Financial reinsurance contracts that meet the risk transfer rules, i.e. involve a significant transfer of insurance risk, shall be accounted for as reinsurance in the revenue and profit and loss account. On the other hand, contracts that do not meet the risk transfer rules shall be treated as deposits by both the ceding and assuming insurers. That is, amounts in respect of such contracts shall be excluded from the revenue and profit and loss account.
Reporting and Disclosure Requirements
(I) For Financial Reinsurance Contracts which Meet the Risk Transfer Rules
In Respect of General Business Ceded
10 For each financial reinsurance contract entered into or modified during the accounting period under which general business has been ceded by the insurer, the insurer shall include as additional information to Form 7: Statement of Premiums, Claims and Underwriting Results, a statement of:
-
the type of business covered or a description of the risks covered if it involves only part of a business category;
-
the type of cover, including such details of the terms and conditions of the contract as are necessary for a proper understanding of the nature of the cover;
-
details of any limits on cover as are necessary for a proper understanding of the contract, including any event limits, limits on the amount of business ceded, limits on the number of reinstatements and aggregate limits; and
-
the period of cover.
Where a contract of reinsurance has been modified during the accounting period in question, the information to be supplied shall be limited to any changes to the information previously supplied.
11 In addition, the ceding insurer shall disclose the following information relating to financial reinsurance contracts as notes to Form 7:
-
the amount of premiums ceded, including any additional payments accrued under the "experience account", included under "reinsurance business ceded" (Rows 6, 7 and 8);
-
the amount of recoveries, included under "recoveries from reinsurance business ceded" (Rows 19, 20 and 21); and
-
the amount of reinsurance commissions received or receivable, including profit commissions or any form of refunds accrued under the "experience account", included under "reinsurance commissions" (Row 31).
12 The ceding insurer shall also disclose the following information relating to financial reinsurance contracts as notes to Form 1: Fund Balance-Sheet:
-
the amount of reinsurance premiums payable and any additional payments accrued under the "experience account",included under "amounts owing to insurers" (Liabilities Row 8);
-
the amount of recoveries receivable, included under "reinsurance recoverables" (Assets Row 14); and
-
any other amounts receivable from reinsurers, such as profit commissions or refunds accrued under the "experience account", included under "investment income due or accrued and other receivables" (Assets Row 11).
In Respect of General Business Assumed
13 For financial reinsurance contracts entered into or modified during the accounting period, the assuming insurer shall disclose as notes to Form 7:
-
the total reinsurance premiums written, included under "reinsurance business accepted" (Rows 2, 3 and 4).
14 In completing Form 1, amounts relating to financial reinsurance contracts shall be reported as follows:
-
amounts owing to cedents, including recoveries, commissions, profit commissions or refunds, shall be included as "amounts owing to insurers" (Liabilities Row 8);
-
premiums receivable from cedents shall be included as "outstanding premiums and agents' balances" (Assets Row 12); and
-
(iii) any additional payments accrued and receivable from cedents under the "experience account" shall be included as "investment income due or accrued and other receivables" (Assets Row 11).
(II) For Financial Reinsurance Contracts which Do Not Meet the Risk Transfer Rules
15 Where amounts in respect of financial reinsurance contracts that do not meet the risk transfer rules have been excluded from the revenue and profit and loss account, the following information shall be disclosed as notes to Form 1:
-
a description of the terms of that contract;
-
a description of the accounting treatment adopted and an explanation for adopting that treatment;
-
a statement of the amounts paid and received during the accounting period under that contract; and
-
a statement of the amounts in respect of that contract included in Form 1.
An insurer may elect to show the information required above in respect of groups of contracts that were effected in the same financial year with substantially the same contract terms and in respect of which the same accounting treatment has been adopted.
Effective Date
16 This Notice shall apply to both annual and quarterly returns for accounting periods ended 30 September 1999 and later. For quarterly returns, insurers are not required to provide the additional information on financial reinsurance contracts as notes to Forms 1 and 7, as required in the case of annual returns.
17 These guidelines, however, shall not apply retrospectively to financial reinsurance contracts that had been entered into prior to the issuance of this Notice.
