Question ID: 1316
Regulation Reference: Guidelines on application of outwards reinsurance
Article: 41
Status: Final
Date of submission: 20 Mar 2018
Question
Quota share with variable and profit commissions. This means risk mitigation only applies when loss ratio goes above a certain level (say 80% loss ratio). It is like a partially placed stop loss.
Initially this covers losses arising within premium risk and catastrophe risk only (no reserves accrued yet).
Recoveries only occur after the loss ratio reaches 80%. If best estimate loss ratio is 75%, then a 5% deterioration in loss ratio is needed before recoveries can be allowed for.
For premium risk, the approach to risk mitigation is defined, and the risk mitigation will be in line with the fall in net earned premium. This overstates the benefit of the quota share as it takes no account of the 5% deterioration, but is a prescribed approach.
Within catastrophe risk, we could look at the standalone catastrophe risk and allow for the benefit of the quota share, i.e. apply a proportional reduction to catastrophe risk, but then add back in the quota share proportion of the 5% deterioration in loss ratio that would not have been recoverable, at the standalone cat level.
But then when you aggregate up to non-life underwriting risk, the amount of reinsurance is being overstated.
The alternative is to look at non-life underwriting risk arising from the risks that are eligible for the quota share (i.e. premium and catastrophe risk only) and apply a proportional reduction at that level, then offset by the 5% deterioration that would not be recoverable. Then, we would need to disaggregate between premium and catastrophe risk. Premium risk is defined, as per regulations, and catastrophe risk would be the balancing item.
Whilst this would ensure the correct amount of reinsurance is being allowed for in the SF SCR as a whole, it would lead to standalone catastrophe risk being overstated, as it also absorbs the 5% deterioration that should have applied to premium risk.
So in summary, the question is, where you have reinsurance that applies across premium and catastrophe risk, should you ensure the reinsurance is not double counted at all levels of the SF SCR calculation or just at the catastrophe risk level, given that only catastrophe risk can be adjusted to reflect any double counting.
EIOPA answer
The following structure of a quota share reinsurance contract has been assessed.
A quota share arrangement with, which we assume to be a 60% QS-treaty (60% of the premium and the claims being transferred to the reinsurer). The QS comes with a clause that the ceded claims are only paid if the overall loss ratio of the portfolio is above 80%. The BE loss ratio for this portfolio is 75%. The insurer is compensated for the extra losses (only reimbursed in case of loss ratio above 80%) via 'variable and profit commissions'.
The question is how this reinsurance structure should be used in the calculation of the SCR for premium and reserve risk and for SCR on Cat risk.
We agree with the questioner that there is no impact on the SCR for reserve risk, because the BE claims in only 75%. For the premium risk SCR the reinsurance structure leads to a reduction of the net (of reinsurance) premium volume.
For the Cat-risk, the reinsurance structure can be applied to the Cat-SCR-calculation by using the mitigating effect in the combined A and B-scenario calculations of the standard formula.
Based on point 1.34 of Guideline 15, with regard to calculating the mitigating effect of the Quota Share contract for the Cat-SCR-calculation, it is allowed to take into account Best Estimate losses for other risks that are not included in the Cat Risk module.
However, considering GL 15, 1.35, it is clear that double counting of risk mitigation benefits should be avoided, this means that the reduction of the SF SCR should to be aligned with after reinsurance resulting risk profile of the insurance undertaking
Based on these general considerations double counting issues involved with reinsurance benefits, should be considered on the level of the total SF SCR (in this case the SCR- NL-underwriting risk).