Question ID: 2537
Regulation Reference: (EU) No 2015/35 - supplementing Dir 2009/138/EC - taking up & pursuit of the business of Insurance and Reinsurance (SII)
Topic: Reinsurance
Article: 9 and 192(6) of DR (EU) 2015/35
Status: Final
Date of submission: 30 Nov 2022
Question
Insurer B has a 100% quota share reinsurance contract with Reinsurer C that includes a “pay as paid clause”. This clause specifies that Insurer B has no liability to the Original Insured A until Reinsurer C has paid the reinsurance claim to Insurer B.
The original insurance contract between the Insurer B and the Original Insured A references the specific quota share reinsurance contract in place and its “pay as paid clause”. It specifies that it is a condition precedent to any liability of Insurer B under the original insurance contract that Insurer B receives payment of the corresponding amount from Reinsurer C. It further states that to the extent that Insurer B does not receive payment from Reinsurer C, Insurer B shall not be liable to the Original Insured A under the original insurance contract.
In other words, Reinsurer C must pay Insurer B before Insurer has any contractual obligation to the Original Insured A.
From the point of view of Insurer B, under the Solvency II technical provisions and Standard Formula:
1. When does a claim by the Original Insured A against Insurer B (along with the associated reinsurance asset from Reinsurer C) become a contractual obligation on Insurer B’s Solvency II balance sheet?
2. Would you need to adjust the cash flows to all for the probability of default when determining the value of the reinsurance asset from Reinsurer C (implying that the cash flows used to determine the gross liability would also be adjusted by the same probabilities)?
3. Would the reinsurance asset from Reinsurer C carry any counterparty risk?
4. Would any claims by the Original Insured A against Insurer B (along with the associated reinsurance recovery from Reinsurer C) carry any reserve risk? (gross or net)
5. Would any claims by the Original Insured A against Insurer B (along with the associated reinsurance recovery from Reinsurer C)carry any catastrophe risk?
EIOPA answer
This answer only analyses the treatment of this type of clauses for Solvency II purposes, provided the clause is fully compliant with the relevant national law and that the contract between the original insured A and insurer B is classified as an insurance contract.
The Solvency II treatment of contracts including pay as paid clauses depend on the specific case. In some cases, this type of clauses may only allow for a delay in payment (“pay when paid"), while in other there may be an actual release from obligations (“pay if paid"). In some cases, the contracts where this type of clauses have been included will provide some additional covers or services, while in others the pay as paid clause may affect all the cover and services provided under the contract. Therefore, each case should be analysed individually to ensure a proper Solvency II treatment.
It should be noted that in cases where the pay as paid clause is included both contracts, i.e., the original contract between the original insured A and the insurer B as well as the contract between the insurer B and reinsurer C, incontrovertibly ceding all the risk to the reinsurer and where the original contract between the original insured A and the insurer B is not providing any additional service or cover, undertakings should recognise the transaction according to the principle of substance over form. This means that, in such a case, insurer B should not recognise technical provisions and recoverables based on the contracts but, instead, it should recognise payables and receivables following Article 9 of the Delegated Regulation.
Regarding the treatment under the Standard Formula for insurer B, the receivables should be recognised under the counterparty default risk module according to Art. 192(6) Delegated Regulation. Further note that more generally scenario-based modules allow for an accurate calculation of the risk-mitigating effect of this type of clauses. However, for formula-based risk sub-modules, in some cases an accurate calculation of the risk-mitigating effect of the clause may only be achieved through a (partial) internal model. In any case, the appropriateness of the Standard Formula should be assessed on a case-by-case basis.